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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
COMMISSION FILE NO.: 2-25805
FAUQUIER BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA 54-1288193
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10 COURTHOUSE SQUARE, WARRENTON, VIRGINIA 20186
(Address of principal executive offices) (Zip Code)
(540) 347-2700
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $3.13 PER SHARE
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes__ No __X__
The aggregate market value of the shares of the registrant's common shares held
by "non-affiliates" of the registrant, based upon the closing sale price of its
common stock on the NASDAQ SmallCap Market System on June 28, 2002, was
approximately $42,834,000. Shares held by each officer, director and holder of
10% or more of the registrant's outstanding common stock have been excluded in
that such persons or entities may be deemed to be affiliates. Such determination
of affiliate status is not a conclusive determination for other purposes.
The registrant had 3,298,938 shares of common stock outstanding as of March 19,
2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the 2003 Annual Meeting of
Shareholders to be filed within 120 days of the fiscal year ended December 31,
2002 are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
Page
PART I
Item 1. Business 1
Item 2. Properties 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Executive Officers of the Registrant 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 12
Item 6. Selected Financial Data 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 32
Item 8. Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 67
PART III
Item 10. Directors and Executive Officers of the Registrant 68
Item 11. Executive Compensation 68
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 68
Item 13. Certain Relationships and Related Transactions 68
Item 14. Controls and Procedures 69
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 70
Signatures and Certifications 72
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PART I
ITEM 1. BUSINESS
GENERAL
Fauquier Bankshares, Inc. ("Bankshares") was incorporated under the laws of the
Commonwealth of Virginia on January 13, 1984. Bankshares is a registered bank
holding company and owns all of the voting shares of The Fauquier Bank ("TFB").
Bankshares engages in its business through TFB, a Virginia state-chartered bank
that commenced operations in 1902. Bankshares has no significant operations
other than owning the stock of TFB. Bankshares had issued and outstanding
3,304,066 shares of common stock, par value $3.13 per share, held by
approximately 396 holders of record on December 31, 2002.
TFB has seven full service branch offices located in the Virginia communities of
Warrenton, Catlett, The Plains, Sudley Road-Manassas, Old Town-Manassas and New
Baltimore. The executive offices of Bankshares and the main office of TFB are
located at 10 Courthouse Square, Warrenton, Virginia 20186. TFB has entered into
a contract to buy a property in Bealeton, Virginia, and subject to satisfaction
of certain conditions, including receipt of required governmental and regulatory
approvals, plans to open its eighth full-service branch office in Bealeton
during 2003.
THE FAUQUIER BANK
TFB's general market area principally includes Fauquier County, western Prince
William County, and neighboring communities and is located approximately sixty
(60) miles southwest of Washington, D.C.
TFB provides a range of consumer and commercial banking services to individuals,
businesses and industries. The deposits of TFB are insured up to applicable
limits by the Bank Insurance Fund of the Federal Deposit Insurance Fund. The
basic services offered by TFB include: demand interest bearing and non-interest
bearing accounts, money market deposit accounts, NOW accounts, time deposits,
safe deposit services, credit cards, cash management, direct deposits, notary
services, money orders, night depository, traveler's checks, cashier's checks,
domestic collections, savings bonds, bank drafts, automated teller services,
drive-in tellers, internet banking, and banking by mail. In addition, TFB makes
secured and unsecured commercial and real estate loans, issues stand-by letters
of credit and grants available credit for installment, unsecured and secured
personal loans, residential mortgages and home equity loans, as well as
automobile and other types of consumer financing. TFB provides automated teller
machine ("ATM") cards, as a part of the Star and Plus ATM networks, thereby
permitting customers to utilize the convenience of larger ATM networks.
TFB operates a Wealth Management Services ("WMS") division that began with the
granting of trust powers to TFB in 1919. The WMS division provides personalized
services that include investment management, trust, estate settlement,
retirement, insurance, and brokerage services. During 2002, assets managed by
WMS increased by $19.2 million to $171.3 million, or 12.7%, when compared with
2001, with revenue decreasing from $705,000 to $694,000 or 1.5%, over the same
time period. The Fauquier Bank through its subsidiary Fauquier Bank Services,
Inc. has equity ownership interests in Bankers Insurance, LLC, a Virginia
independent insurance company, and Bankers Investments Group, LLC, a full
service broker/dealer. Bankers Insurance consists of a consortium of 56 Virginia
community bank owners and Bankers Investments Group is owned by 28 Virginia
community banks. TFB recognized equity investment losses of $23,000 for Bankers
Insurance and $14,000 for Bankers Investments Group in 2002 related to the
start-up expenses of these businesses, which accounted for the year to year
decline in WMS revenues.
The revenues of TFB are primarily derived from interest on, and fees received in
connection with, real estate and other loans, and from interest and dividends
from investment and mortgage-backed securities, and short-term investments. The
principal sources of funds for TFB's lending activities are its deposits,
repayment of loans, the sale and maturity of investment securities, and
borrowings from the Federal Home Loan Bank ("FHLB") of Atlanta. The principal
expenses of TFB are the interest paid on deposits and operating and general
administrative expenses.
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As is the case with banking institutions generally, TFB's operations are
materially and significantly influenced by general economic conditions and by
related monetary and fiscal policies of financial institution regulatory
agencies, including the Board of Governors of the Federal Reserve System
("Federal Reserve"). As a Virginia-chartered bank and a member of the Federal
Reserve, TFB is supervised and examined by the Federal Reserve and the Virginia
State Corporation Commission ("SCC"). Interest rates on competing investments
and general market rates of interest influence deposit flows and costs of funds.
Lending activities are affected by the demand for financing of real estate and
other types of loans, which in turn is affected by the interest rates at which
such financing may be offered and other factors affecting local demand and
availability of funds. TFB faces strong competition in the attraction of
deposits (its primary source of lendable funds) and in the origination of loans.
See "Competition" below.
As of December 31, 2002, Bankshares had total consolidated assets of $321.5
million, total consolidated deposits of $273.7 million, and total consolidated
shareholders' equity of $26.4 million.
LENDING ACTIVITIES
TFB offers a range of lending services, including real estate, consumer and
commercial loans, to individuals as well as small to medium sized businesses and
other organizations that are located in or conduct a substantial portion of
their business in TFB's market area. TFB's total loans, net of allowance, at
December 31, 2002 were $213.7 million, or 66.5% of total assets. The interest
rates charged on loans vary with the degree of risk, maturity, and amount of the
loan, and are further subject to competitive pressures, money market rates,
availability of funds, and government regulations. TFB has no foreign loans or
loans for highly leveraged transactions.
TFB's primary market area consists of Fauquier and Prince William Counties,
Virginia and the surrounding communities. There is no assurance that this area
will experience economic growth. Adverse conditions in any one or more of the
industries operating in Fauquier or Prince William Counties, or a slow-down in
general economic conditions could have an adverse effect on Bankshares and TFB.
TFB's loans are concentrated in three major areas: real estate loans, consumer
loans, and commercial loans. Approximately 9.4% and 16.3% of TFB's loan
portfolio at December 31, 2002 consisted of commercial and consumer loans,
respectively. The majority of TFB's loans are made on a secured basis. As of
December 31, 2002, approximately 70.0% of the loan portfolio consisted of loans
secured by mortgages on real estate.
LOANS SECURED BY REAL ESTATE
ONE TO FOUR ("1-4") FAMILY RESIDENTIAL LOANS. TFB's 1-4 family residential
mortgage loan portfolio primarily consists of conventional loans, with interest
rates fixed for 10 years or less, and balloon loans with 3, 5, 7, 10, or 15-year
maturities and amortized for 30 years or less. As of December 31, 2002, TFB's
conventional 1-4 family residential loans amounted to $76.6 million, or 35.4% of
the total loan portfolio. Substantially all of TFB's single-family residential
mortgage loans are secured by properties located in TFB's service area. The
majority of residential mortgage loans originated by TFB are originated under
terms and documentation that permit the loans to be sold to Freddie Mac.
Loans with a fixed rate longer than 15 years are generally sold into the
secondary market. TFB does not retain the servicing of sold loans.
TFB requires private mortgage insurance ("PMI") if the principal amount of the
loan exceeds 80% of the value of the property held as collateral. TFB uses the
underwriting guidelines of the PMI provider for loans having a loan-to-value
ratio in excess of 80%. TFB also considers the income of the borrower in
determining whether to make single-family residential mortgage loans.
CONSTRUCTION LOANS. The majority of TFB's construction loans are made to
individuals to construct a primary residence. Such loans have a maximum term of
nine months, a fixed rate of interest, and loan-to-value ratios of 80% or less
of the appraised value upon completion. TFB requires that permanent financing,
with TFB or some other lender, be in place prior to closing any construction
loan. Construction loans are generally
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considered to involve a higher degree of credit risk than single-family
residential mortgage loans. The risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion.
TFB also provides construction loans and lines of credit to developers. Such
loans generally have maximum loan-to-value ratios of 80% of the appraised value
upon completion. The loans are made with a fixed rate of interest. The majority
of such loans consists of loans to selected local developers known to TFB for
the building of single-family dwellings on either a pre-sold or speculative
basis. TFB limits the number of unsold units under construction at one time.
Loan proceeds are disbursed in stages after inspections of the project indicate
that such disbursements are for costs already incurred and that have added to
the value of the project. Construction loans include loans to developers to
acquire the necessary land, develop the site and construct the residential
units. As of December 31, 2002, TFB's construction loans totaled $10.7 million,
or 4.9% of the total loan portfolio.
COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate comprised
$62.0 million, or 28.6% of total loans at December 31, 2002, and consist
principally of commercial loans for which real estate constitutes a source of
collateral. These loans are secured primarily by owner-occupied properties.
Commercial real estate loans generally involve a greater degree of risk than
single-family residential mortgage loans because repayment of commercial real
estate loans may be more vulnerable to adverse conditions in the real estate
market or the economy.
CONSUMER LOANS
TFB's consumer loan portfolio consists primarily of loans to individuals for
various consumer purposes, but includes some business purpose loans that are
payable on an installment basis. TFB offers a wide variety of consumer loans,
including installment loans, credit card loans, home equity loans, and other
secured and unsecured credit facilities. Most of these loans are for terms of
less than five years and are secured by liens on various personal assets of the
borrowers, but consumer loans may also be made on an unsecured basis. Consumer
loans are made at fixed and variable rates, and are often based on up to a
five-year amortization schedule. The consumer loan portfolio was $35.4 million
or 16.3% of total loans at December 31, 2002.
COMMERCIAL LOANS
TFB's commercial loans include loans to individuals and small-to-medium sized
businesses located primarily in Fauquier and Prince William Counties for working
capital, equipment purchases, and various other business purposes. Equipment or
similar assets secure a majority of TFB's commercial loans, but these loans may
also be made on an unsecured basis. Commercial loans have variable or fixed
rates of interest. Commercial lines of credit are typically granted on a
one-year basis. Other commercial loans with terms or amortization schedules
longer than one year will normally carry interest rates that vary with the prime
lending rate and other financial indexes and will be payable in full in three to
five years.
Loan originations are derived from a number of sources, including existing
customers and borrowers, walk-in customers, advertising, and direct solicitation
by TFB's loan officers.
Certain credit risks are inherent in making loans. These include prepayment
risks, risks resulting from uncertainties in the future value of collateral,
risks resulting from changes in economic and industry conditions, and risks
inherent in dealing with individual borrowers. In particular, longer maturities
increase the risk that economic conditions will change and adversely affect our
ability to collect. TFB attempts to minimize loan losses through various means.
In particular, on larger credits, TFB generally relies on the cash flow of a
debtor as the source of repayment and secondarily on the value of the underlying
collateral. In addition, TFB attempts to utilize shorter loan terms in order to
reduce the risk of a decline in the value of such collateral.
DEPOSIT ACTIVITIES
Deposits are the major source of TFB's funds for lending and other investment
activities. TFB considers the majority of its regular savings, demand, NOW and
money market deposit accounts to be core deposits. These
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accounts comprised approximately 74.3% of TFB's total deposits at December 31,
2002. Approximately 25.7% of TFB's deposits at December 31, 2002 were
certificates of deposit. Generally, TFB attempts to maintain the rates paid on
its deposits at a competitive level. Time deposits of $100,000 and over made up
approximately 8.4% of TFB's total deposits at December 31, 2002 and generally
pay interest at the same rates as certificates of less than $100,000. The
majority of TFB's deposits are generated from Fauquier and Prince William
Counties. TFB has not accepted brokered deposits to date, but will continue to
evaluate many funding sources, including the use of brokered deposits, as part
of its asset/liability management process.
INVESTMENTS
TFB invests a portion of its assets in U.S. Treasury and U.S. Government
corporation and agency obligations, state, county and municipal obligations,
corporate obligations, mutual funds, FHLB stock, and equity securities. TFB's
investments are managed in relation to loan demand and deposit growth, and are
generally used to provide for the investment of excess funds at reduced yields
and risks relative to yields and risks of the loan portfolio, while providing
liquidity to fund increases in loan demand or to offset fluctuations in
deposits. TFB does not currently engage in any off-balance sheet hedging
activities. TFB's total investments, at fair value, were $71.7 million, or 22.3%
of total assets at December 31, 2002.
GOVERNMENT SUPERVISION AND REGULATION
GENERAL. Bank holding companies and banks are extensively regulated under both
federal and state law. The following summary briefly addresses certain
provisions of federal and state laws that apply to Bankshares or TFB. This
summary does not purport to be complete and is qualified in its entirety by
reference to the particular statutory or regulatory provisions.
SARBANES-OXLEY ACT OF 2002. Bankshares is subject to the periodic reporting
requirements of the Securities and Exchange Act of 1934, as amended (the
"Exchange Act"), including the filing of annual, quarterly, and other reports
with the Securities and Exchange Commision (the "SEC"). As an Exchange Act
reporting company, Bankshares is directly affected by the recently enacted
Sarbanes-Oxley Act of 2002 (the "SOX"), which is aimed at improving corporate
governance, internal controls and reporting procedures. Bankshares is complying
with new SEC and other rules and regulations implemented pursuant to the SOX and
intends to comply with any applicable rules and regulations implemented in the
future.
FINANCIAL SERVICES MODERNIZATION LEGISLATION. On November 12, 1999, President
Clinton signed into law the Gramm-Leach-Bliley Financial Services Modernization
Act of 1999 (the "Act"), federal legislation intended to modernize the financial
services industry by establishing a comprehensive framework to permit
affiliations among commercial banks, insurance companies, securities firms and
other financial service providers under a financial company structure.
Although Bankshares could qualify to become a financial holding company under
the Act, it does not contemplate seeking to do so until it identifies
significant specific benefits from doing so. Bankshares does not believe that
the Act will have a material adverse effect on its operations in the near-term.
However, to the extent that the Act permits banks, securities firms and
insurance companies to affiliate, the financial services industry may experience
further consolidation. This could result in a growing number of financial
institutions that offer a wider variety of financial services than Bankshares
currently offers and that can aggressively compete in the markets Bankshares
currently serves.
BANK HOLDING COMPANY REGULATION. Bankshares is a one-bank holding company,
registered with the Federal Reserve under the Bank Holding Company Act of 1956
("BHC Act"). As such, Bankshares is subject to the supervision, examination, and
reporting requirements of the BHC Act and the regulations of the Federal
Reserve. Bankshares is required to furnish to the Federal Reserve an annual
report of its operations at the end of each fiscal year and such additional
information as the Federal Reserve may require pursuant to the BHC Act.
4
The BHC Act requires every bank holding company to obtain the prior approval of
the Federal Reserve before (i) it may acquire direct or indirect ownership or
control of any voting shares of any bank if, after such acquisition, the bank
holding company will directly or indirectly own or control more than 5% of the
total voting shares of the bank, (ii) it or any of its subsidiaries, other than
a bank, may acquire all or substantially all of the assets of the bank, or (iii)
it may merge or consolidate with any other bank holding company.
The BHC Act further provides that the Federal Reserve may not approve any
transaction that would result in a monopoly or would be in furtherance of any
combination or conspiracy to monopolize or attempt to monopolize the business of
banking in any section of the United States, or the effect of which may be
substantially to lessen competition or to tend to create a monopoly in any
section of the country, or that in any other manner would be in restraint of
trade, unless the anti-competitive effects of the proposed transaction are
clearly outweighed by the public interest in meeting the convenience and needs
of the community to be served. The Federal Reserve also considers the financial
and managerial resources and future prospects of the bank holding companies and
banks concerned as well as the convenience and needs of the community to be
served. Consideration of financial resources generally focuses on capital
adequacy, while consideration of convenience and needs issues focuses on the
parties' performance under the Community Reinvestment Act of 1977 (the "CRA").
The BHC Act generally prohibits Bankshares from engaging in activities other
than banking or managing or controlling banks or other permissible subsidiaries
and from acquiring or retaining direct or indirect control of any company
engaged in any activities other than those activities determined by the Federal
Reserve to be sufficiently related to banking or managing or controlling banks.
In determining whether a particular activity is permissible, the Federal Reserve
considers whether the performance of the activity reasonably can be expected to
produce benefits to the public, such as greater convenience, increased
competition, or gains in efficiency, that outweigh possible adverse effects,
such as undue concentration of resources, decreased or unfair competition,
conflicts of interests, or unsound banking practices. For example, factoring
accounts receivable, acquiring or servicing loans, leasing personal property,
conducting discount securities brokerage activities, performing certain data
processing services, acting as agent or broker in selling credit life insurance
and certain other types of insurance in connection with credit transactions, and
performing certain insurance underwriting activities all have been determined by
the Federal Reserve to be permissible activities of bank holding companies.
Despite this prior approval, however, the Federal Reserve has the power to order
a bank holding company or its subsidiaries to terminate any activity or to
terminate its ownership or control of any subsidiary when it has reasonable
cause to believe that continuation of such activity or such ownership or control
constitutes a serious risk to the financial safety, soundness, or stability of
any bank subsidiary of that bank holding company.
As a bank, TFB is subject to the provisions of the CRA. Under the terms of the
CRA, the appropriate federal bank regulatory agency is required, in connection
with its examination of a bank, to assess the bank's record in meeting the
credit needs of the community served by that bank, including low- and
moderate-income neighborhoods. The regulatory agency's assessment of the bank's
record is made available to the public. Such assessment is required of any bank
that has applied to (i) charter a national bank, (ii) obtain deposit insurance
coverage for a newly chartered institution, (iii) establish a new branch office
that will accept deposits, (iv) relocate an office, or (v) merge or consolidate
with, or acquire the assets or assume the liabilities of, a federally regulated
financial institution. In the case of a bank holding company applying for
approval to acquire a bank or other bank holding company, the Federal Reserve
will assess the record of each subsidiary bank of the applicant bank holding
company, and such records may be the basis for denying the application.
BANK REGULATION. TFB is chartered under the laws of the Commonwealth of
Virginia. The Federal Deposit Insurance Corporation (the "FDIC") insures its
deposits to the maximum extent provided by law. TFB is subject to comprehensive
regulation, examination and supervision by the Federal Reserve and to other laws
and regulations applicable to banks. These regulations include limitations on
loans to a single borrower and to TFB's directors, officers and employees;
restrictions on the opening and closing of branch offices; requirements
regarding the maintenance of prescribed capital and liquidity ratios;
requirements to grant credit under equal and fair conditions; and requirements
to disclose the costs and terms of such credit. State regulatory authorities
also have broad enforcement powers over TFB, including the power to impose fines
and other civil or criminal penalties and to appoint a receiver in order to
conserve TFB's assets for the benefit of depositors and other creditors.
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Under federal law, federally insured banks are subject, with certain exceptions,
to certain restrictions on any extension of credit to their parent holding
companies or other affiliates, on investment in the stock or other securities of
affiliates, and on the taking of such stock or securities as collateral from any
borrower. In addition, federally insured banks are prohibited from engaging in
certain tie-in arrangements in connection with any extension of credit or the
providing of any property or service.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") contained major regulatory reforms, increased capital standards for
savings and loan associations and strengthened civil and criminal enforcement
provisions. FIRREA provides that a depository institution insured by the FDIC
can be held liable for any loss incurred by, or reasonably expected to be
incurred by, the FDIC after August 9, 1989 in connection with (i) the default of
a commonly controlled FDIC-insured depository institution, or (ii) any
assistance provided by the FDIC to a commonly controlled FDIC-insured
institution in danger of default.
The FDIC Improvement Act of 1991 ("FDICIA") made a number of reforms addressing
the safety and soundness of deposit insurance funds, supervision, accounting,
and prompt regulatory action with respect to insured institutions such as TFB.
Annual full-scope, on-site examinations are required of all insured depository
institutions. The cost for conducting an examination of an institution may be
assessed to the institution, with special consideration given to affiliates and
any penalties imposed for failure to provide information requested. Insured
state banks also are precluded from engaging as principal in any type of
activity that is impermissible for a national bank, including activities
relating to insurance and equity investments. FDICIA also re-codified current
law under the Federal Reserve Act restricting extensions of credit to insiders.
DIVIDENDS. Dividends from TFB constitute the primary source of funds for
dividends to be paid by Bankshares. There are various statutory and contractual
limitations on the ability of TFB to pay dividends, extend credit, or otherwise
supply funds to Bankshares, including the requirement under Virginia banking
laws that cash dividends only be paid out of net undivided profits and only if
such dividends would not impair the capital of TFB. The Federal Reserve also has
the general authority to limit the dividends paid by bank holding companies and
state member banks, if the payment of dividends is deemed to constitute an
unsafe and unsound practice. The Federal Reserve has indicated that banking
organizations should generally pay dividends only if (1) the organization's net
income available to common shareholders over the past year has been sufficient
to fund fully the dividends and (2) the prospective rate of earnings retention
appears consistent with the organization's capital needs, asset quality and
overall financial condition. TFB does not expect any of these laws, regulations
or policies to materially impact its ability to pay dividends.
EFFECT OF GOVERNMENTAL POLICIES. The earnings and business of Bankshares and TFB
are affected by the policies of various regulatory authorities of the United
States, especially the Federal Reserve. The Federal Reserve, among other things,
regulates the supply of credit and deals with general economic conditions within
the United States. The instruments of monetary policy employed by the Federal
Reserve for those purposes influence in various ways the overall level of
investments, loans, other extensions of credits, and deposits, and the interest
rates paid on liabilities and received on assets.
ENFORCEMENT POWERS. Congress has provided the Federal Reserve and the FDIC with
an array of powers to enforce laws, rules, regulations and orders. Among other
things, these agencies may require that institutions cease and desist from
certain activities, may preclude persons from participating in the affairs of
insured depository institutions, may suspend or remove deposit insurance, and
may impose civil money penalties against institution-affiliated parties for
certain violations.
MAXIMUM LEGAL INTEREST RATES. Like the laws of many states, Virginia law
contains provisions that limit the interest rates that may be charged by banks
and other lenders on certain types of loans. Numerous exceptions exist to the
general interest limitations imposed by Virginia law. The relative importance of
these interest limitation laws to the financial operations of TFB will vary from
time to time, depending on a number of factors, including conditions in the
money markets, the costs and availability of funds, and prevailing interest
rates.
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CHANGE OF CONTROL. Federal law restricts the amount of voting stock of a bank
holding company and a bank that a person may acquire without the prior approval
of banking regulators. The overall effect of such laws is to make it more
difficult to acquire a bank holding company and a bank by tender offer or
similar means than it might be to acquire control of another type of
corporation. Consequently, shareholders of Bankshares may be less likely to
benefit from the rapid increases in stock prices that can result from tender
offers or similar efforts to acquire control of other companies. Under the
federal Change in Bank Control Act and the regulations thereunder, a person or
group must give advance notice to the Federal Reserve before acquiring control
of any bank holding company. Upon receipt of such notice, the Federal Reserve
may approve or disapprove the acquisition. The Change in Bank Control Act
creates a rebuttable presumption of control if a member or group acquires above
a certain percentage of a bank holding company's or bank's voting stock, or if
one or more other control factors set forth in the Change in Bank Control Act
are present.
INSURANCE OF DEPOSITS. TFB's deposit accounts are insured by the FDIC up to a
maximum of $100,000 per insured depositor. The FDIC issues regulations, conducts
periodic examinations, requires the filing of reports and generally supervises
the operations of its insured banks. Any insured bank that is not operated in
accordance with or does not conform to FDIC regulations, policies and directives
may be sanctioned for non-compliance. Proceedings may be instituted against any
insured bank or any director, officer, or employee of an insured bank engaging
in unsafe and unsound practices, including the violation of applicable laws and
regulations. The FDIC has the authority to terminate insurance of accounts
pursuant to procedures established for that purpose.
CAPITAL REQUIREMENTS. The federal bank regulatory authorities have adopted
risk-based capital guidelines for banks and bank holding companies that are
designed to make regulatory capital requirements more sensitive to differences
in risk profile among banks and bank holding companies. The resulting capital
ratios represent qualifying capital as a percentage of total risk-weighted
assets and off-balance sheet items. The guidelines establish minimums, and the
federal regulators have noted that banks and bank holding companies
contemplating significant expansion programs should maintain all ratios well in
excess of the minimums and should not allow expansion to diminish their capital
ratios. The current guidelines require all bank holding companies and federally
regulated banks to maintain a minimum risk-based total capital ratio equal to
8%, of which at least 4% must be Tier 1 capital. Tier 1 capital includes common
stockholders' equity, retained earnings, qualifying perpetual preferred stock,
and certain hybrid capital instruments, but excludes goodwill and most other
intangibles and excludes the allowance for loan and lease losses. Tier 2 capital
includes the excess of any preferred stock not included in Tier 1 capital,
mandatory convertible securities, certain hybrid capital instruments,
subordinated debt and intermediate term-preferred stock, and general reserves
for loan and lease losses up to 1.25% of risk-weighted assets. As of December
31, 2002, TFB had a total risk-based capital ratio of 15.48% and a Tier 1
risk-based capital ratio of 14.23%, and Bankshares had a total risk-based
capital ratio of 15.52% and a Tier 1 risk-based capital ratio of 14.26%.
Each of the federal regulatory agencies has also established leverage capital
ratio guidelines for banking organizations (Tier 1 capital to average tangible
assets, or the "leverage ratio"). These guidelines provide for a minimum
leverage ratio of 4.00% for banks and bank holding companies. As of December 31,
2002, TFB had a leverage ratio of 9.33%, and Bankshares had a leverage ratio of
9.35%.
FDICIA contains "prompt corrective action" provisions pursuant to which banks
are classified into one of five categories based upon capital adequacy, ranging
from "well capitalized" to "critically undercapitalized" and which require
(subject to certain exceptions) the appropriate federal banking agency to take
prompt corrective action with respect to an institution which becomes
"significantly undercapitalized" or "critically undercapitalized".
The FDIC has issued regulations to implement the "prompt corrective action"
provisions of FDICIA. In general, the regulations define the five capital
categories as follows: (i) an institution is "well capitalized" if it has a
total risk-based capital ratio of 10% or greater, has a Tier 1 risk-based
capital ratio of 6% or greater, has a leverage ratio of 5% or greater and is not
subject to any written order or directive to meet and maintain a specific
capital level for any capital measure; (ii) an institution is "adequately
capitalized" if it has a total risk-based capital ratio of 8% or greater, has a
Tier 1 risk-based capital ratio of 4% or greater, and has a leverage ratio of 4%
or greater; (iii) an institution is "undercapitalized" if it has a total
risk-based capital ratio of less
7
than 8%, has a Tier 1 risk-based capital ratio that is less than 4% or has a
leverage ratio that is less than 4%; (iv) an institution is "significantly
undercapitalized" if it has a total risk-based capital ratio that is less than
6%, has a Tier 1 risk-based capital ratio that is less than 3% or has a leverage
ratio that is less than 3%; and (v) an institution is "critically
undercapitalized" if its "tangible equity" is equal to or less than 2% of its
total assets. TFB was notified by the Federal Reserve Bank of Richmond that, at
December 31, 2002, both Bankshares and TFB were considered "well capitalized."
FDICIA also (i) provides that only a "well capitalized" depository institution
may accept brokered deposits without prior regulatory approval and (ii) requires
the appropriate federal banking agency annually examine all insured depository
institutions, with some exceptions for small, "well capitalized" institutions
and state-chartered institutions examined by state regulators. FDICIA also
contains a number of consumers banking provisions, including disclosure
requirements and substantive contractual limitations with respect to deposit
accounts. The FDIC also has authority to downgrade an institution from "well
capitalized" to "adequately capitalized" or to subject an "adequately
capitalized" or "under-capitalized" institution to the supervisory actions
applicable to the next lower category, for supervisory concerns.
FEDERAL HOME LOAN BANK ("FHLB") OF ATLANTA. TFB is a member of the FHLB of
Atlanta, which is one of twelve regional FHLBs that provide funding to their
members for making housing loans as well as for affordable housing and community
development lending. Each FHLB serves as a reserve or central bank for its
members within its assigned region. It is funded primarily from proceeds derived
from the sale of consolidated obligations of the FHLB system. It makes loans to
its members (i.e., advances) in accordance with policies and procedures
established by the Board of Directors of the FHLB. As a member, TFB is required
to purchase and maintain stock in the FHLB in an amount equal to at least 5% of
the aggregate outstanding advances made by the FHLB to TFB.
USA PATRIOT ACT. The USA PATRIOT Act became effective on October 26, 2001 and
provides for the facilitation of information sharing among governmental entities
and financial institutions for the purpose of combating terrorism and money
laundering. Among other provisions, the USA PATRIOT Act permits financial
institutions, upon providing notice to the United States Treasury, to share
information with one another in order to better identify and report to the
federal government concerning activities that may involve money laundering or
terrorists' activities. Interim rules implementing the USA PATRIOT Act were
issued effective March 4, 2002. This USA PATRIOT Act is considered a significant
banking law in terms of information disclosure regarding certain customer
transactions. Although it does create a reporting obligation, TFB does not
expect the USA PATRIOT Act to materially affect its products, services, or other
business activities.
COMPETITION
Bankshares encounters strong competition both in making loans and in attracting
deposits. In one or more aspects of its business, TFB competes with other
commercial banks, savings and loan associations, credit unions, finance
companies, mutual funds, insurance companies, brokerage and investment banking
companies, and other financial intermediaries. Most of these competitors, some
of which are affiliated with bank holding companies, have substantially greater
resources and lending limits, and may offer certain services that TFB does not
currently provide. In addition, many of TFB's non-bank competitors are not
subject to the same level of federal regulation that governs bank holding
companies and federally insured banks. Recent federal and state legislation has
heightened the competitive environment in which financial institutions must
conduct their business, and the potential for competition among financial
institutions of all types has increased significantly.
To compete, TFB relies upon specialized services, responsive handling of
customer needs, and personal contacts by its officers, directors, and staff.
Large multi-branch banking institutions tend to compete primarily by rate and
the number and location of branches while smaller, independent financial
institutions tend to compete primarily by rate and personal service.
8
EMPLOYEES
As of December 31, 2002, Bankshares and TFB employed 101 full-time employees and
25 part-time employees compared with 95 full-time and 27 part-time employees as
of December 31, 2001. No employee is represented by a collective bargaining
unit. Bankshares and TFB consider relations with employees to be good.
ITEM 2. PROPERTIES
TFB owns or leases property and operates branches at the following locations:
LOCATION LEASE/OWN RENT (ANNUAL) EXPIRATION RENEWAL
- ----------------------------------------------------------------------------------------------------------------------
Main Office *
P.O. Box 561 Own N/A N/A N/A
10 Courthouse Square
Warrenton, VA 20186
Catlett Office
Rt. 28 and 806 Own N/A N/A N/A
Catlett, VA 20119
Sudley Road Office
8091 Sudley Rd. Lease $41,160 2004 Additional 5 yrs.
Manassas, VA 20109
Old Town Office Lease $37,400 from 2001 to 2011 Two additional
Center Street 2006, then $40,700 from options for 10 years
Manassas, VA 20110 2006 to 2011 each.
New Baltimore Office
5119 Lee Highway Own N/A N/A N/A
Warrenton, VA 20187
The Plains Office
6464 Main Street Own N/A N/A N/A
The Plains, VA 20198
View Tree Office
216 Broadview Avenue Own N/A N/A N/A
Warrenton, VA 20186
Finance/Accounting Office
98 Alexandria Pike Lease $29,900 2007 N/A
Warrenton, VA 20186
Bealeton Property Contract Contract
US Rt. 17 & Station Dr. Owner N/A N/A N/A
Bealeton, VA 22712
- ----------------------------------------------------------------------------------------------------------------------
* TFB and Bankshares occupy this location.
All of these properties are in good operating condition and are adequate for
Bankshares' and TFB's present and anticipated future needs. TFB maintains
comprehensive general liability and casualty loss insurance covering its
properties and activities conducted in or about its properties. Management
believes this insurance provides adequate protection for liabilities or losses
that might arise out of the ownership and use of these properties.
9
ITEM 3. LEGAL PROCEEDINGS
There are no pending or threatened legal proceedings to which Bankshares or TFB
is a party or to which the property of either Bankshares or TFB is subject that,
in the opinion of management, may materially impact the financial condition of
either company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth quarter of
the fiscal year ended December 31, 2002.
10
EXECUTIVE OFFICERS OF THE REGISTRANT
POSITION HELD WITH COMPANY AND/OR PRINCIPAL FIRST YEAR AS
OCCUPATIONS AND DIRECTORSHIPS DURING THE PAST EXECUTIVE AGE AS OF
FIVE YEARS OFFICER OF DECEMBER 31,
NAME COMPANY 2002
C. Hunton Tiffany Chairman of the Board of Bankshares and TFB 1984 63
since 1984. Chief Executive Officer and
President of Bankshares since 1982. Chief
Executive Officer of TFB from 1982 to June,
2003. President of TFB from 1982 to 2002.
Director of TFB since 1974.
Randy K. Ferrell Senior Vice President of Bankshares since 1994 52
1994. Chief Executive Officer of TFB
effective June, 2003. President of TFB since
2002. Chief Operating Officer of TFB from
2002 to June, 2003. Executive Vice President
of TFB, Commercial and Retail Banking/MIS
from 2001 to 2002.
Gary R. Shook Senior Vice President of Bankshares and TFB, 1995 42
Wealth Management Services, since 1995.
Rosanne T. Gorkowski Senior Vice President of Bankshares and TFB, 2000 57
Human Resources and Administration since
2000. Vice President of TFB from 1999 to
2000. Director of Human Resources for Walcoff
Associates, a Fairfax, VA based information
technology company, from 1997 to 1999.
Eric P. Graap Senior Vice President and Chief Financial 2000 49
Officer of Bankshares and TFB since 2000.
Treasurer and Chief Financial Officer of The
Community Preservation Corporation, a New
York, NY based community development
financial company from 1994 to 2000.
Mark A. Debes Senior Vice President of TFB, Retail Banking 2002 37
since 2002. Vice President of TFB from 1998
to 2002. Branch Manager for Eastern Bank,
Boston, MA from 1997 to 1998.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Bankshares' common stock is traded over the counter market on the National
Association of Securities Dealers Automated Quotation ("NASDAQ") on the SmallCap
Market System under the symbol "FBSS". Bankshares' common stock commenced
trading on December 27, 1999.
As of December 31, 2002, there were 3,304,066 shares outstanding of Bankshares'
common stock, which is Bankshares' only class of stock outstanding. These shares
were held by approximately 396 holders of record. The following table sets forth
the high and low sales prices for Bankshares' common stock and the amounts of
the cash dividends paid for each full quarterly period within the two most
recent fiscal years:
2002 2001 Dividends Per Share
--------------------- ---------------------- -------------------------
High Low High Low 2002 2001
--------------------- ---------------------- -------------------------
1st Quarter $ 13.50 $ 12.06 $ 8.88 $ 7.38 $ 0.10 $ 0.085
2nd Quarter $ 16.35 $ 13.25 $ 10.25 $ 8.30 $ 0.10 $ 0.085
3rd Quarter $ 15.10 $ 13.91 $ 12.00 $ 10.03 $ 0.10 $ 0.095
4th Quarter $ 16.90 $ 14.42 $ 12.48 $ 11.00 $ 0.11 $ 0.095
All amounts in the table above have been restated to reflect the 100% stock
dividend in 2002.
Bankshares' future dividend policy is subject to the discretion of the Board of
Directors and will depend upon a number of factors, including future earnings,
financial condition, cash requirements, and general business conditions.
Bankshares' ability to pay cash dividends will depend entirely upon TFB's
ability to pay dividends to Bankshares.
Transfers of funds from TFB to Bankshares in the form of loans, advances and
cash dividends are restricted by federal and state regulatory authorities. As of
December 31, 2002, the aggregate amount of unrestricted funds that could be
transferred from TFB to Bankshares without prior regulatory approval totaled
$3.9 million.
12
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operation" and the consolidated financial statements and
accompanying notes included elsewhere in this report. The historical results are
not necessarily indicative of results to be expected for any future period.
SELECTED FINANCIAL DATA
At and for the Year Ended December 31,
(Dollars in thousands, except per share data) 2002 2001 2000 1999 1998
EARNINGS STATEMENT DATA:
Interest income $ 19,496 $ 19,785 $ 18,002 $ 17,129 $ 15,024
Interest expense 5,082 7,221 6,084 6,043 5,519
--------- --------- --------- --------- ---------
Net interest income 14,414 12,564 11,918 11,086 9,505
Provision for loan losses 346 350 457 695 535
--------- --------- --------- --------- ---------
Net interest income after provision
for loan losses 14,068 12,214 11,461 10,391 8,970
Noninterest income 3,866 3,836 2,842 2,433 2,202
Securities gains (losses) 34 -- (111) -- 17
Noninterest expense 12,296 10,938 9,665 9,023 7,708
--------- --------- --------- --------- ---------
Income before income taxes 5,672 5,112 4,527 3,801 3,481
Income taxes 1,742 1,597 1,430 1,162 1,039
--------- --------- --------- --------- ---------
Net income $ 3,930 $ 3,515 $ 3,097 $ 2,639 $ 2,442
========= ========= ========= ========= =========
PER SHARE DATA: (1)
Net income per share, basic 1.18 1.03 0.88 0.73 0.66
Net income per share, diluted 1.14 1.01 0.88 0.73 0.65
Cash dividends 0.41 0.36 0.32 0.28 0.225
Average basic shares outstanding 3,312,084 3,406,866 3,510,364 3,604,330 3,714,564
Average diluted shares outstanding 3,460,128 3,473,696 3,533,546 3,636,264 3,751,282
Book value at period end 8.00 7.21 6.55 5.98 5.76
BALANCE SHEET DATA:
Total Assets $ 321,499 $ 285,202 $ 249,855 $ 233,208 $ 220,026
Loans, net 213,698 207,453 197,879 181,503 162,272
Investment securities 71,737 36,908 16,956 18,779 22,791
Deposits 273,668 243,747 212,103 187,273 179,217
Shareholders' equity 26,431 24,157 22,419 21,204 21,177
PERFORMANCE RATIOS:
Net interest margin(2) 5.24% 5.02% 5.56% 5.35% 5.35%
Return on average assets 1.29% 1.28% 1.32% 1.14% 1.21%
Return on average equity 15.74% 14.73% 14.13% 12.50% 11.60%
Dividend payout 34.51% 34.76% 36.09% 34.34% 34.10%
Efficiency ratio(3) 66.44% 65.78% 64.69% 63.51% 65.90%
ASSET QUALITY RATIOS:
Allowance for loan losses to period
end loans, net 1.34% 1.36% 1.27% 1.24% 1.13%
Nonperforming loans to allowance for
loan losses 29.20% 31.96% 4.74% 5.49% 35.96%
Non-performing assets to period end loans
and other real estate owned 0.39% 0.43% 0.06% 0.07% 0.44%
Net charge-offs to average loans 0.14% 0.02% 0.10% 0.15% 0.23%
CAPITAL AND LIQUIDITY RATIOS:
Leverage 9.35% 8.30% 9.13% 8.80% 9.70%
Risk Based Capital Ratios:
Tier 1 capital 14.26% 12.00% 11.96% 12.20% 13.10%
Total capital 15.52% 13.25% 13.21% 13.40% 14.30%
(1) Amounts have been restated to reflect a two-for-one stock split during 1998
and a 100% stock dividend during 2002.
(2) Net interest margin is calculated as fully taxable equivalent net interest
income divided by average earning assets and represents the Corporation's net
yield on its earning assets.
(3) Efficiency ratio is computed by dividing non-interest expense by the sum of
fully taxable equivalent net interest income and non-interest income.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion is qualified in its entirety by the more detailed
information and the financial statements and accompanying notes appearing
elsewhere in this Form 10-K. In addition to the historical information contained
herein, this report contains 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. Forward-looking statements are
based on certain assumptions and describe future plans, strategies, and
expectations of Bankshares, and are generally identifiable by use of the words
"believe," "expect," "intend," "anticipate," "estimate," "project" "may," "will"
or similar expressions. Although we believe our plans, intentions and
expectations reflected in these forward-looking statements are reasonable, we
can give no assurance that these plans, intentions, or expectations will be
achieved. Our ability to predict results or the actual effect of future plans or
strategies is inherently uncertain, and actual results, performances or
achievements could differ materially from those contemplated. Factors that could
have a material adverse effect on our operations and future prospects include,
but are not limited to, changes in: interest rates, general economic conditions,
the legislative/regulatory climate, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Board of Governors
of the Federal Reserve System, the quality or composition of TFB's loan or
investment portfolios, demand for loan products, deposit flows, competition,
demand for financial services in our market area and accounting principles,
policies and guidelines. These risks and uncertainties should be considered in
evaluating forward-looking statements contained herein and you should not place
undue reliance on such statements, which reflect our position as of the date of
this report.
INTRODUCTION
This discussion is intended to focus on certain financial information regarding
Bankshares and TFB. The purpose of this discussion is to provide the reader with
a more thorough understanding of the financial statements. As such, this
discussion should be read in conjunction with the consolidated financial
statements and accompanying notes contained elsewhere herein.
Management is not aware of any market or institutional trends, events or
uncertainties that are expected to have a material effect on the liquidity,
capital resources or operations of Bankshares or TFB. Nor is management aware of
any current recommendations by regulatory authorities that would have a material
effect on liquidity, capital resources or operations. TFB's internal sources of
such liquidity are deposits, loan repayments and securities available for sale.
TFB's primary external source of liquidity is advances from the FHLB of Atlanta.
CRITICAL ACCOUNTING POLICIES
GENERAL. Bankshares' financial statements are prepared in accordance with
accounting principles generally accepted in the United States (GAAP). The
financial information contained within our statements is, to a significant
extent, based on measures of the financial effects of transactions and events
that have already occurred. A variety of factors could affect the ultimate value
that is obtained either when earning income, recognizing an expense, recovering
an asset or relieving a liability. We use historical loss factors as one factor
in determining the inherent loss that may be present in our loan portfolio.
Actual losses could differ significantly from the historical factors that we use
in our estimates. In addition, GAAP itself may change from one previously
acceptable accounting method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the
losses that may be sustained in our loan portfolio. The allowance is based on
two basic principles of accounting: (i) Statement of Financial Accounting
Standards (SFAS) No. 5 "Accounting for Contingencies," which requires that
losses be accrued when they are probable of occurring and estimable and (ii)
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," which requires
that losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
14
Our allowance for loan losses has three basic components: the specific
allowance, the formula allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when the
actual events occur.
The specific allowance is used to individually allocate an allowance for larger
balance, non-homogeneous loans. The specific allowance uses various techniques
to arrive at an estimate of loss. First, analysis of the borrower's overall
financial condition, resources and payment record, the prospects for support
from financial guarantors, and the fair market value of collateral are used to
estimate the probability and severity of inherent losses. Additionally, the
migration of historical default rates and loss severities, internal risk
ratings, industry and market conditions and trends, and other environmental
factors are considered. The use of these values is inherently subjective and our
actual losses could be greater or less than the estimates.
The formula allowance is used for estimating the loss on pools of
smaller-balance, homogeneous loans; including one-to-four family mortgage loans,
installment loans, other consumer loans, and outstanding loan commitments. Also,
the formula allowance is used for the remaining pool of larger balance,
non-homogeneous loans which were not allocated a specific allowance upon their
review. The formula allowance begins with estimates of probable losses inherent
in the homogeneous portfolio based upon various statistical analyses. These
include analysis of historical and peer group delinquency and credit loss
experience, together with analyses that reflect current trends and conditions.
We also consider trends and changes in the volume and term of loans, changes in
the credit process and/or lending policies and procedures, and an evaluation of
overall credit quality. The formula allowance uses a historical loss view as an
indicator of future losses. As a result, even though this history is regularly
updated with the most recent loss information, it could differ from the loss
incurred in the future.
The unallocated allowance captures losses that are attributable to various
economic events, industry or geographic sectors whose impact on the portfolio
have occurred but have yet to be recognized in either the formula or specific
allowances. In addition, an unallocated reserve is maintained to recognize the
imprecision in estimating and measuring inherent losses on individual loans or
pools of loans.
OVERVIEW
The reported results of Bankshares depend on a variety of factors, including the
general interest rate environment, competitive conditions in the industry,
governmental policies and regulations and conditions in the markets for
financial assets. Net interest income is the largest component of net income,
and consists of the difference between income generated on interest-earning
assets and interest expense incurred on interest-bearing liabilities. Net
interest income is primarily affected by the volume, interest rates and
composition of interest-earning assets and interest-bearing liabilities.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2002 AND
DECEMBER 31, 2001
Net income of $3.9 million in 2002 was a 11.8% increase from 2001 net income of
$3.5 million. Earnings per share (EPS) on a fully diluted basis were $1.14 in
2002 compared to $1.01 in 2001. Profitability as measured by return on average
equity increased from 14.7% in 2001 to 15.7% in 2002. Profitability as measured
by return on average assets increased from 1.28% in 2001 to 1.29% in 2002.
On January 29, 2001, TFB recovered $358,000, net of taxes, or $0.10 per diluted
share, from its insurance carrier for losses associated with a misappropriation
of cash. Certain expenses associated with that misappropriation of cash reduced
2000 and 1999 earnings by $86,000 and $288,000, net of tax, respectively.
15
On December 6, 2001, earnings were reduced by $378,000 net of tax benefit, or
$0.11 per diluted share, due to an extraordinary expense associated with the
early payoff of the FHLB of Atlanta advances. The restructuring of TFB's balance
sheet through the early payoff of the FHLB of Atlanta borrowings resulted from
the greater-than-anticipated success of TFB's retail deposit retention campaign.
Deposits grew by $31.6 million, or 14.9%, from December 31, 2000 to December 31,
2001. The benefit of this restructuring strategy, in addition to increasing
TFB's flexibility in its asset/liability management process, included the
reduction of interest expense during 2002 and beyond. The realized and
anticipated reduction in interest expense is projected to more than offset the
one-time extraordinary expense of the early payoff.
NET INTEREST INCOME. Total interest income decreased $289,000 or 1.5% to $19.5
million in 2002 from $19.8 million in 2001. This decrease was primarily due to
the decrease in yield on interest-earning assets resulting from the declining
market interest rates. Average loan balances increased from $208.8 million in
2001 to $215.7 million in 2002. The average yield on loans decreased to 8.05% in
2002 compared with 8.51% in 2001. Together, there was a $394,000 decrease in
interest and fee income from loans for the year 2002 compared with year 2001 on
a tax equivalent basis. Average investment security balances increased $24.3
million from $26.9 million in 2001 to $51.1 million in 2002, primarily due to
the excess liquidity generated from retail deposit growth. The tax-equivalent
average yield on investments declined from 5.84% in 2001 to 4.21% in 2002.
Together, there was an increase in tax equivalent interest and dividend income
on security investments of $585,000 or 37.3%, from $1.6 million in 2001 to $2.2
million in 2002. Average federal funds sold balances decreased $6.3 million from
$18.8 million in 2001 to $12.5 million in 2002. The average yield on federal
funds sold declined from 3.59% in 2001 to 1.58% in 2002. Together, there was a
$479,000 decrease in federal funds sold income from 2001 to 2002.
Total interest expense decreased $2.1 million or 29.6% from 2001 to 2002
primarily due to the decrease in cost on interest-bearing deposits also
resulting from the declining market interest rates. Average deposit balances
grew $30.3 million, primarily in demand deposits and money market accounts. The
average rate on interest-bearing liabilities decreased from 3.54% in 2001 to
2.25% in 2002. The average rate on certificates of deposit decreased from 5.57%
in 2001 to 3.81% in 2002. Interest expense on FHLB of Atlanta advances decreased
$252,000 from 2001 to 2002 due to the early repayment of advances in December
2001.
Net interest income for 2002 increased $1.8 million or 14.7% to $14.4 million
for the year ended December 31, 2002 from $12.6 million for the year ended
December 31, 2001. This increase resulted from an increase in total average
earning assets from $254.6 million in 2001 to $279.5 million in 2002, and a 22
basis point improvement in the net interest margin. The percentage of average
earning assets to total assets decreased in 2002 to 92.0% from 93.0% in 2001.
TFB's net interest margin increased from 5.02% in 2001 to 5.24% in 2002.
Future trends regarding net interest income are dependent on the absolute level
of market interest rates, the shape of the yield curve, the amount of lost
income from non-performing assets, the amount of prepaying loans, the mix and
amount of various deposit types, and many other factors, as well as the overall
volume of interest-earning assets. These factors are individually difficult to
predict, and when taken together, the uncertainty of future trends compounds.
Based on management's current projections, net interest income may increase in
2003 as average interest-earning assets increase, but this may be offset in part
or whole by a possible contraction in TFB's net interest margin resulting from
economic market conditions.
PROVISION FOR LOAN LOSSES. The provision for loan losses was $346,000 for 2002
and $350,000 for 2001. The amount of the provision for loan loss for 2002 and
2001 was based upon management's continual evaluation of the adequacy of the
allowance for loan losses, which encompasses the overall risk characteristics of
the loan portfolio, trends in TFB's delinquent and non-performing loans,
estimated values of collateral, and the impact of economic conditions on
borrowers. During 2001, TFB refined its policies, guidelines, and methods for
determining the allowance for loan losses, and allocating the allowance among
various loan categories. Greater weight was given to the loss history by loan
category, prolonged changes in portfolio delinquency trends by loan category,
and changes in economic trends. There can be no assurances, however, that future
losses will not exceed estimated amounts, or that increased amounts of
provisions for loan losses will not be required in future periods.
16
NON-INTEREST INCOME. Total non-interest income increased by $64,000 from $3.8
million in 2001 to $3.9 million in 2002. Excluding the previously discussed
non-loan charge-off insurance recovery of $542,000 before taxes during 2001,
total other income increased by $607,000, or 18.4%. Other income is derived
primarily from non-interest fee income, which consists primarily of fiduciary
and other Wealth Management fees, service charges on deposit accounts, and other
fee income. In 2002, the increase was generated primarily from a $420,000
increase in service charges on deposit accounts. Major factors in the increase
in service charges on deposit accounts were the impact of the 12.3% increase in
TFB's deposit base from year-end 2001 to year-end 2002, as well as management's
focus on meeting the needs of its customers with new value-added, fee-based
products.
NON-INTEREST EXPENSE. Total non-interest expenses increased $1.4 million, or
12.4% in 2002 from 2001. The primary component of the increase was an increase
in salaries and employees' benefits of $1.0 million, or 21.3%, primarily due to
the increase in full-time equivalent personnel from approximately 114 at
year-end 2001 and 104 at year-end 2000 to 119 at year-end 2002, as well as
customary annual salary increases. Significant increases in the defined-benefit
pension plan expense and the cost of medical insurance benefits also added to
increased salary and employees' benefit expense in 2002. The growth in personnel
primarily reflects the expansion of the Wealth Management Services and Lending
divisions, and the full year effect of the August 2001 opening of the Old
Town-Manassas branch office. In addition, occupancy expenses increased $140,000,
or 23.6%, from 2001 to 2002 primarily due to rent and other leasehold expenses
associated with the full year effect of the Old Town-Manassas office, as well as
the 2002 addition of administrative offices in Alexandria Pike, Warrenton.
Furniture and equipment increased $188,000 or 21.8%, which correspond with the
growth in occupancy expenses.
INCOME TAXES. Income tax expense increased by $145,000 for the year ended
December 31, 2002 compared to the year ended December 31, 2001. The effective
tax rates were 30.7% for 2002 and 31.2% for 2001. The effective tax rate differs
from the statutory federal income tax rate of 34% due to TFB's investment in
tax-exempt loans and securities.
The following table presents a quarterly summary of earnings for the last two
years. In 2002, earnings exhibited an increasing profitability from recurring
sources, primarily the result of the steady and continuous growth in net
interest income and fees on deposits.
EARNINGS
(In Thousands)
Three Months Ended 2002 Three Months Ended 2001
DEC. 31 SEP. 30 JUNE 30 MAR. 31 DEC. 31 SEP. 30 JUNE 30 MAR. 31
---------------------------------------------- ---------------------------------------------
Interest income $ 4,951 $ 4,888 $ 4,954 $ 4,703 $ 4,962 $ 5,019 $ 5,003 $ 4,801
Interest expense 1,128 1,264 1,358 1,332 1,622 1,887 1,903 1,817
------ ------ ------ ------ ------ ------ ------ -----
Net Interest Income 3,823 3,624 3,596 3,371 3,340 3,132 3,100 2,984
Provision for loan losses 93 65 94 94 75 75 100 100
------ ------ ------ ------ ------ ------ ------ -----
Net interest income after
provision for loan losses 3,730 3,559 3,502 3,277 3,265 3,057 3,000 2,884
Other Income 1,096 999 877 928 946 873 754 1,263
Other Expense 3,385 3,054 2,963 2,895 3,322 2,530 2,572 2,507
------ ------ ------ ------ ------ ------ ------ -----
Income before income taxes 1,441 1,504 1,416 1,310 889 1,400 1,182 1,640
Income tax expense 426 473 444 398 269 443 371 513
------ ------ ------ ------ ------ ------ ------ -----
Net income 1,015 1,031 972 912 620 957 811 1,127
====== ====== ====== ====== ====== ====== ====== =====
Net income per share, basic $ 0.31 $ 0.31 $ 0.29 $ 0.27 $ 0.18 $ 0.28 $ 0.24 $ 0.33
Net income per share, diluted $ 0.29 $ 0.30 $ 0.28 $ 0.27 $ 0.17 $ 0.27 $ 0.24 $ 0.33
17
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2001 AND
DECEMBER 31, 2000
Net income of $3.5 million in 2001 represented a 13.5% increase from 2000 net
income of $3.1 million. Earnings per share (EPS) on a fully diluted basis were
$1.01 in 2001 compared to $0.88 in 2000. Profitability as measured by return on
average equity increased from 14.1% in 2000 to 14.7% in 2001. As discussed in
more detail in the "Comparison of Operating Results for the Years Ended December
31, 2002 and December 31, 2001," on January 29, 2001, TFB recovered $358,000,
net of taxes, or $0.10 per diluted share, from its insurance carrier for losses
associated with the misappropriation of cash, and on December 6, 2001, earnings
were reduced by $378,000 net of tax benefit, or $0.11 per diluted share, due to
an extraordinary expense associated with the early payoff of FHLB of Atlanta
advances.
NET INTEREST INCOME. Total interest income grew $1.8 million or 9.9% to $19.8
million in 2001 from $18.0 million in 2000. This increase was primarily the
result of growth in loan and investment security balances. Average loan balances
increased from $193.4 million in 2000 to $208.8 million in 2001. The average
yield on loans decreased to 8.51% in 2001 compared with 8.64% in 2000. Together,
there was a $1.0 million increase in interest and fee income from loans for the
year 2001 compared with year 2000. Average investment security balances
increased $10.0 million from $16.9 million in 2000 to $26.9 million in 2001,
primarily due to the excess liquidity generated from a retail deposit retention
campaign. The tax-equivalent average yield on investments declined from 6.08% in
2000 to 5.84% in 2001. Together, there was an increase in interest and dividend
income on security investments of $0.5 million or 54.7%, from $1.0 million in
2000 to $1.5 million in 2001.
18
Total interest expense increased $1.1 million or 18.7% from 2000 to 2001
primarily due to the growth in deposits. Average deposit balances grew $33.4
million, primarily in demand deposits and time certificates of deposit. The
average rate on interest-bearing liabilities increased slightly from 3.52% in
2000 to 3.54% in 2001 due to the fourth quarter 2000 growth in higher rate
certificates of deposit. The average rate on certificates of deposit increased
from 5.11% in 2000 to 5.57% in 2001. During the fourth quarter of 2001, many of
these higher rate certificates of deposit either repriced into lower rate
certificates of deposit, or transferred into lower rate NOW, money market
account, and savings account rates.
Net interest income for 2001 increased $645,000 or 5.4% to $12.6 million for the
year ended December 31, 2001 from $11.9 million for the year ended December 31,
2000. This increase resulted from an increase in total average earning assets
from $217.7 million in 2000 to $254.6 million in 2001, which offset the decline
in the net interest margin. The percentage of average earning assets to total
assets increased slightly in 2001 to 93.0% from 92.6%. TFB's net interest margin
decreased from 5.56 % in 2000 to 5.02% in 2001.
PROVISION FOR LOAN LOSSES. The provision for loan losses was $350,000 for 2001
and $457,000 for 2000. The amount of the provision for loan loss for 2001 and
2000 was based upon management's continual evaluation of the adequacy of the
allowance for loan losses, which encompasses the overall risk characteristics of
the loan portfolio, trends in TFB's delinquent and non-performing loans,
estimated values of collateral, and the impact of economic conditions on
borrowers.
NON-INTEREST INCOME. Total non-interest income increased by $1.1 million from
$2.7 million for 2000 to $3.8 million for 2001. Excluding the previously
discussed non-loan charge-off insurance recovery of $542,000 before taxes, total
other income increased by $563,000, or 20.6%. Other income is derived primarily
from non-interest fee income, which consists primarily of fiduciary and other
Wealth Management fees, service charges on deposit accounts, and other fee
income. In 2001, the increase stemmed from a $106,000 increase in Wealth
Management fees, and a $228,000 increase in service charges on deposit accounts.
Major factors in the increase in service charges on deposit accounts were
management's focus on meeting the needs of its customers with new value-added,
fee-based products, as well as the impact of a 14.9% increase in TFB's deposit
base from year-end 2000 to year-end 2001.
NON-INTEREST EXPENSE. Total non-interest expenses increased $1.3 million, or
13.2% in 2001 from 2000. The primary component of the increase was an increase
in salaries and employees' benefits of $743,000, or 18.1%, primarily due to the
increase in full-time equivalent personnel from approximately 104 at year-end
2000 to 114 at year-end 2001, as well as customary annual salary increases and
increases in medical insurance benefits. The growth in personnel primarily
reflects the expansion of the Wealth Management Services division and the August
2001 opening of the Old Town-Manassas branch office. In addition, occupancy
expenses increased $125,000, or 26.7%, primarily due to rent and other leasehold
expenses associated with the new Old Town-Manassas office. Other operating
expenses increased from $4.3 million in 2000 to $4.6 million in 2001 due to the
prepayment penalty of $573,000 associated with the repayment of FHLB of Atlanta
advances offsetting the absence of investigation-related expenses as a result of
the misappropriation of cash.
INCOME TAXES. Income tax expense increased by $167,000 for the year ended
December 31, 2001 compared to the year ended December 31, 2000. The effective
tax rates were 31.2% for 2001 and 31.6% for 2000. The effective tax rate differs
from the statutory federal income tax rate of 34% due to TFB's investment in
tax-exempt loans and securities.
COMPARISON OF DECEMBER 31, 2002 AND DECEMBER 31, 2001 FINANCIAL CONDITION
Total assets were $321.5 million at December 31, 2002, an increase of 12.7% or
$36.3 million from $285.2 million at December 31, 2001. Balance sheet categories
reflecting significant changes included investment securities, total loans,
deposits, and capital securities. Each of these categories is discussed below.
INVESTMENT SECURITIES. Total investment securities were $71.7 million at
December 31, 2002, reflecting an increase of $34.8 million from $36.9 million at
December 31, 2001. The increase was the result of investing funds, generated by
retail deposit growth, primarily into mortgage-backed securities with
shorter-term
19
durations of two to three years. At December 31, 2002 and 2001, all
$36.9 million in investment securities were available for sale. The valuation
allowance for the available for sale portfolio had an unrealized gain, net of
tax, of $670,000 at December 31, 2002 compared with an unrealized gain, net of
tax, of $227,000 at December 31, 2001.
LOANS. Total net loan balance after allowance for loan losses was $213.7 million
at December 31, 2002, which represents an increase of $6.2 million or 3.0% from
$207.5 million at December 31, 2001. The majority of the increase was in 1-4
family residential real estate loans, which increased $4.0 million from 2001 to
2002 and commercial and industrial loans, except those secured by real estate,
which increased $5.2 million over the same time period. The growth in 1-4 family
residential real estate loans and commercial and industrial loans was partially
offset by the decrease in construction loans. TFB's loans are made primarily to
customers located within TFB's primary market area.
DEPOSITS. For the year ended December 31, 2002, total deposits grew $29.9
million or 12.3% when compared with total deposits one year earlier.
Noninterest-bearing deposits increased by $9.5 million and interest-bearing
deposits increased by $20.4 million.
COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY TRUST
("Capital Securities"). On March 26, 2002, Bankshares established a subsidiary
trust that issued $4.0 million of capital securities as part of a pooled trust
preferred security offering with other financial institutions. Bankshares is
using the offering proceeds for the purposes of expansion and the repurchase of
additional shares of its common stock. Under applicable regulatory guidelines,
the capital securities are treated as Tier 1 capital for purposes of the Federal
Reserve's capital guidelines for bank holding companies, as long as the capital
securities and all other cumulative preferred securities of Bankshares together
do not exceed 25% of Tier 1 capital.
ASSET QUALITY
Non-performing loans, in most cases, consist of loans that are 90 days or more
past due and for which the accrual of interest has been discontinued. Management
evaluates all loans that are 90 days or more past due, as well as loans that
have suffered financial distress, to determine if they should be placed on
non-accrual status. Factors considered by management include the estimated value
of collateral, if any, and other resources of the borrower that may be available
to satisfy the delinquency.
Non-performing loans totaled approximately $850,000 or .39% of total loans at
December 31, 2002, as compared with $913,000, or .43% of total loans at December
31, 2001. Non-performing loans as a percentage of the allowance for loan losses
were 29.2% and 32.0% at December 31, 2002 and 2001, respectively.
Loans that were 90 days past due and accruing interest totaled $244,000 and
$541,000 at December 31, 2002 and 2001, respectively. At December 31, 2002,
$198,000 of the $244,000 consisted of two loans secured by real estate. No loss
is anticipated on these loans.
There are no loans, other than those disclosed above as either non-performing or
impaired, where information known about the borrower has caused management to
have serious doubts about the borrower's ability to repay. There are no other
interest-bearing assets that would be subject to disclosure as either
non-performing or impaired if such interest-bearing assets were loans. To
management's knowledge, no concentration of loans to borrowers engaged in
similar activities exceeds 10% of total loans.
CAPITAL RESOURCES AND LIQUIDITY
Shareholders' equity totaled $26.4 million at December 31, 2002 compared with
$24.2 million at December 31, 2001. The amount of equity reflects management's
desire to increase shareholders' return on equity by managing the growth in
equity. During the first quarter of 1998, Bankshares initiated a Dutch auction
self-tender offer to repurchase shares directly from shareholders. As a result
of this action, Bankshares repurchased 120,476 shares, as adjusted for stock
splits, or 3.2% of shares outstanding on December 31, 1998, for $1.2
20
million. In addition to the Dutch Auction, Bankshares initiated an open market
buyback program in 1998, through which it repurchased, adjusted for stock
splits, an additional 30,000 shares at a cost of $0.3 million in 1998; 136,426
shares at a cost of $1.3 million in 1999; 126,240 shares at a cost of $1.1
million in 2000; 77,916 shares at a cost of $0.9 million in 2001; and 77,394
shares at a cost of $1.1 million in 2002.
The securities portfolio valuation account increased its unrealized gain after
tax to $670,000 at December 31, 2002 compared to an unrealized gain of $227,000
at December 31, 2001.
As discussed above under "Comparison of December 31, 2002 and December 31, 2001
Financial Condition," on March 26, 2002, Bankshares established a subsidiary
trust that issued $4.0 million of capital securities as part of a pooled trust
preferred security offering with other financial institutions. Under applicable
regulatory guidelines, the capital securities are treated as Tier 1 capital for
purposes of the Federal Reserve's capital guidelines for bank holding companies,
as long as the capital securities and all other cumulative preferred securities
of Bankshares together do not exceed 25% of Tier 1 capital.
As discussed above under "Government Supervision and Regulation," banking
regulations have established minimum capital requirements for financial
institutions, including risk-based capital ratios and leveraged ratios. As of
December 31, 2002, the appropriate regulatory authorities have categorized
Bankshares and TFB as "well capitalized."
The primary sources of funds are deposits, repayment of loans, maturities of
investments, funds provided from operations and advances from the FHLB of
Atlanta. While scheduled repayments of loans and maturities of investment
securities are predictable sources of funds, deposit flows and loan repayments
are greatly influenced by the general level of interest rates, economic
conditions and competition. TFB uses its sources of funds to fund existing and
future loan commitments, to fund maturing certificates of deposit and demand
deposit withdrawals, to invest in other interest-earning assets, to maintain
liquidity, and to meet operating expenses. Management monitors projected
liquidity needs and determines the desirable funding level based in part on
TFB's commitments to make loans and management's assessment of TFB's ability to
generate funds.
Cash and amounts due from depository institutions and federal funds sold totaled
$24.9 million at December 31, 2002 compared with $30.2 million at December 31,
2001. These assets provide the primary source of liquidity for TFB. In addition,
management has designated the entire investment portfolio, approximately $71.7
million, as available for sale, and has an available line of credit with the
FHLB of Atlanta with a borrowing limit of approximately $49.4 million at
December 31, 2002 to provide additional sources of liquidity. At December 31,
2002, $15.0 million of the FHLB of Atlanta line of credit was in use.
CERTAIN STATISTICAL INFORMATION
The information contained on page 13 of this Report on Form 10-K in Item 6,
under the caption "Selected Financial Data" is incorporated herein by reference.
21
The following table sets forth information relating to Bankshares' average
balance sheet and reflects the average yield on assets and average cost of
liabilities for the periods indicated and the average yields and rates paid for
the periods indicated. Such yields and costs are derived by dividing income or
expense by the average daily balances of assets and liabilities, respectively,
for the periods presented.
AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(In Thousands)
2002 2001 2000
-------------------------- -------------------------- ---------------------------
Average Income/ Average Average Income/ Average Average Income/ Average
ASSETS: Balances Expense Rate Balances Expense Rate Balances Expense Rate
---------- -------- ------ --------- -------- ------- --------- --------- ------
Loans
Taxable $208,726 $16,863 8.08% $202,854 $17,330 8.54% $188,935 $16,357 8.66%
Tax-exempt (1) 6,128 509 8.31% 4,969 436 8.77% 4,257 345 8.11%
Nonaccrual 889 -- 980 -- 219 --
---------- -------- --------- -------- --------- ---------
Total Loans 215,743 17,372 8.05% 208,803 17,766 8.51% 193,411 16,702 8.64%
---------- -------- --------- -------- --------- ---------
Securities
Taxable 48,768 1,990 4.08% 23,569 1,334 5.66% 14,209 841 5.92%
Tax exempt (1) 2,364 164 6.94% 3,288 235 7.13% 2,651 184 6.95%
---------- -------- --------- -------- --------- ---------
Total securities 51,132 2,154 4.21% 26,857 1,569 5.84% 16,860 1,025 6.08%
---------- -------- --------- -------- --------- ---------
Deposits in banks 174 3 1.72% 91 3 3.16% 105 5 5.02%
Federal funds sold 12,489 197 1.58% 18,839 676 3.59% 7,331 450 6.14%
---------- -------- --------- -------- --------- ---------
Total earning assets 279,538 19,726 7.06% 254,590 20,014 7.86% 217,707 18,182 8.35%
-------- -------- ---------
Less: Reserve for loan losses (2,957) (2,778) (2,569)
Cash and due from banks 16,563 11,917 9,846
Bank premises and equipment, net 6,532 5,621 5,464
Other assets 4,258 4,355 4,548
---------- --------- ---------
Total Assets $303,934 $273,705 $234,996
========== ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits
Demand deposits $51,016 -- $43,628 -- $37,123 --
---------- -------- --------- -------- --------- ---------
Interest-bearing deposits
NOW accounts 46,403 165 0.36% 39,980 262 0.66% 37,201 415 1.12%
Money market accounts 53,348 932 1.75% 36,307 1,049 2.89% 34,969 1,185 3.39%
Savings accounts 37,833 439 1.16% 32,137 695 2.16% 32,869 881 2.68%
Time deposits 70,179 2,671 3.81% 76,469 4,256 5.57% 53,001 2,707 5.11%
---------- -------- --------- -------- --------- ---------
Total interest-bearing deposits 207,763 4,207 2.02% 184,893 6,262 3.39% 158,040 5,188 3.28%
Federal Home Loan Bank advances 15,000 705 4.70% 18,874 957 5.07% 15,022 896 5.96%
Capital Securities of Subsidiary Trust 3,079 170 5.52% -- -- -- --
---------- -------- --------- -------- --------- ---------
Total interest-bearing liabilities 225,842 5,082 2.25% 203,767 7,220 3.54% 173,062 6,084 3.52%
---------- -------- --------- -------- --------- ---------
Other liabilities 2,112 2,445 2,899
---------- --------- ---------
Shareholders' equity 24,964 23,865 21,912
---------- --------- ---------
Total Liabilities & Shareholders' Equity $303,934 $273,705 $234,996
========== ========= =========
-------- -------- -------
Net interest spread $14,644 4.81% $12,794 4.32% $12,098 4.83%
======== ======== =======
Interest expense as a percent of average
earning assets 1.82% 2.84% 2.79%
Net interest margin 5.24% 5.02% 5.56%
(1) Income and rates on non-taxable assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
22
RATE/VOLUME ANALYSIS
The following table sets forth certain information regarding changes in interest
income and interest expense of Bankshares for the periods indicated. For each
category of interest-earning asset and interest-bearing liability, information
is provided on changes attributable to changes in volume (change in volume
multiplied by old rate); and changes in rates (change in rate multiplied by old
volume). Changes in rate-volume, which cannot be separately identified, are
allocated proportionately between changes in rate and changes in volume.
RATE/VOLUME VARIANCE
(In Thousands)
2002 Compared to 2001 2001 Compared to 2000
----------------------------------------- ------------------------------------------
Due to Due to Due to Due to
Change Volume Rate Change Volume Rate
----------- -------------- -------------- ------------- ------------- --------------
INTEREST INCOME:
Loans; taxable $ (467) $ 543 $ (1,010) $ 973 $ 1,205 $ 232
Loans; tax-exempt 73 94 (21) 91 58 33
Securities; taxable 656 888 (232) 493 554 (61)
Securities; tax-exempt (71) (64) (7) 51 44 7
Deposits in banks -- -- -- (2) (1) (1)
Federal funds sold (479) (180) (299) 226 706 (480)
----------- -------------- -------------- ------------- ------------- --------------
Total Interest Income (288) 1,281 (1,569) 1,832 2,566 (734)
----------- -------------- -------------- ------------- ------------- --------------
INTEREST EXPENSE:
NOW accounts (97) 53 (150) (153) 31 (184)
Money market accounts (117) (733) 616 (136) 45 (181)
Savings accounts (256) 159 (415) (186) (20) (166)
Time deposits (1,585) (327) (1,258) 1,549 1,199 350
Federal Home Loan Bank Advances (252) (186) (66) 61 230 (169)
Capital Securities of Subsidiary Trust 170 170 -- -- -- --
----------- -------------- -------------- ------------- ------------- --------------
Total Interest Expense (2,137) (864) (1,273) 1,135 1,485 (350)
----------- -------------- -------------- ------------- ------------- --------------
Net Interest Income $ 1,849 $ 2,145 $ (296) $ 697 $ 1,081 $ (384)
=========== ============== ============== ============= ============= ==============
23
LOAN PORTFOLIO
At December 31, 2002 and 2001, net loans accounted for 66.5% and 72.7%,
respectively, of total assets and were the largest category of Bankshares'
earning assets.
Loans are shown on the balance sheets net of unearned discounts and the
allowance for loan losses. Interest is computed by methods that result in level
rates of return on principal. Loans are charged-off when deemed by management to
be uncollectable, after taking into consideration such factors as the current
financial condition of the customer and the underlying collateral and
guarantees.
Bankshares adopted FASB Statement No. 114, "Accounting by Creditors for
Impairment of a Loan." This Statement has been amended by FASB No. 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures." FASB Statement No. 114, as amended, requires that the impairment
of loans that have been separately identified for evaluation is to be measured
based on the present value of expected future cash flows or, alternatively, the
observable market price of the loans or the fair value of the collateral.
However, for those loans that are collateral dependent (that is, if repayment of
those loans is expected to be provided solely by the underlying collateral) and
for which management has determined foreclosure is probable, the measure of
impairment is to be based on the fair value of the collateral. FASB Statement
No. 114, as amended also requires certain disclosures about investments in
impaired loans and the allowance for loan losses and interest income recognized
on loans.
A loan is considered impaired when it is probable that TFB will be unable to
collect all principal and interest amounts according to the contractual terms of
the loan agreement. Factors involved in determining impairment include, but are
not limited to, expected future cash flows, financial condition of the borrower,
and the current economic conditions. A performing loan may be considered
impaired if the factors above indicate a need for impairment. A loan on
non-accrual status may not be impaired if it is in the process of collection or
if the shortfall in payment is insignificant. A delay of less than 30 days or a
shortfall of less than 5% of the required principal and interest payments
generally is considered "insignificant" and would not indicate an impairment
situation, if in management's judgement the loan will be paid in full. Loans
that meet the regulatory definitions of doubtful or loss generally qualify as
impaired loans under FASB Statement No. 114. Charge-offs for impaired loans
occur when the loan or portion of the loan is determined to be uncollectible, as
is the case for all loans.
Bankshares considers all consumer installment loans and residential mortgage
loans to be homogenous loans. These loans are not subject to individual
impairment under FASB Statement No. 114.
Loans are placed on non-accrual status when they have been specifically
determined to be impaired or when principal or interest is delinquent for 90
days or more, unless the loans are well secured and in the process of
collection. Any unpaid interest previously accrued on such loans is reversed
from income. Interest income generally is not recognized on specific impaired
loans unless the likelihood of further loss is remote. Interest payments
received on such loans are applied as a reduction of the loan principal balance.
Interest income on other non-accrual loans is recognized only to the extent of
interest payments received.
Total loans on the balance sheet are comprised of the following classifications
as of December 31, 2002, 2001, 2000, 1999, and 1998.
LOAN PORTFOLIO (IN THOUSANDS)
December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------- ------------- ------------ ------------
Loans secured by real estate:
Construction $ 10,685 $ 16,851 $ 12,948 $ 11,746 $ 8,297
Secured by Farmland 2,416 2,220 381 903 1,163
1-4 Family Residential 76,646 72,692 74,167 64,921 53,430
Commercial Real Estate 62,030 62,845 53,959 50,988 49,814
Commercial and industrial loans
(except those secured by real estate) 20,386 15,154 17,148 16,689 16,933
Consumer loans to individuals (except those
secured by real estate) 35,397 34,640 36,083 33,787 30,284
All other loans 9,186 5,962 5,873 4,868 4,620
------------ ------------- ------------- ------------ ------------
Total loans 216,746 210,364 200,559 183,902 164,541
Less: Unearned discount 138 54 126 115 416
------------ ------------- ------------- ------------ ------------
Total loans, net of unearned discount $216,608 $210,310 $200,433 $183,787 $164,125
============ ============= ============= ============ ============
24
The following table sets forth certain information with respect to TFB's
non-accrual, restructured and past due loans, as well as foreclosed assets, for
the periods indicated:
NON-PERFORMING ASSETS AND LOANS CONTRACTUALLY PAST DUE
(In Thousands)
Years ended December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------ ------------ ------------
Nonaccrual loans $850 $ 913 $121 $125 $666
Restructured loans -- -- -- -- --
Other real estate owned -- -- -- -- 57
------------- ------------- ------------ ------------ ------------
Total Non-Performing Assets $850 $913 $121 $125 $723
============= ============= ============ ============ ============
Loans past due 90 days
accruing interest $244 $541 $800 $170 $951
============= ============= ============ ============ ============
Allowance for loan losses to
total loans at period end 1.34% 1.36% 1.27% 1.24% 1.13%
Non-performing assets to
period end loans and other
real estate owned 0.39% 0.43% 0.06% 0.07% 0.44%
Potential Problem Loans: At December 31, 2002, Management is not aware of any
significant problem loans not included in table.
25
SUMMARY OF LOAN LOSS EXPERIENCE
ANALYSIS OF LOAN LOSS EXPERIENCE. The allowance for loan losses is maintained at
a level which, in management's judgement, is adequate to absorb credit losses
inherent in the loan portfolio. The amount of the allowance is based on
management's evaluation of the collectibility of the loan portfolio, credit
concentration, trends in historical loss experience, specific impaired loans,
and current economic conditions. Management periodically reviews the loan
portfolio to determine probable credit losses related to specifically identified
loans as well as credit losses inherent in the remainder of the loan portfolio.
Allowances for impaired loans are generally determined based on collateral
values or the present value of estimated cash flows. The allowance is increased
by a provision for loan losses, which is charged to expense and reduced by
charge-offs, net of recoveries. Changes in the allowances relating to impaired
loans are charged or credited to the provision for loan losses. Because of
uncertainties inherent in the estimation process, management's estimate of
credit losses inherent in the loan portfolio and the related allowance remains
subject to change.
Additions to the allowance for loan losses, recorded as the provision for loan
losses on Bankshares' statements of income, are made monthly to maintain the
allowance at an appropriate level based on management's analysis of the inherent
risk in the loan portfolio. The amount of the provision is a function of the
level of loans outstanding, the level of non-performing loans, historical
loan-loss experience, the amount of loan losses actually charged off or
recovered during a given period and current national and local economic
conditions.
At December 31, 2002, 2001, 2000, 1999, and 1998 the allowance for loan losses
was $2,910,000, $2,857,000, $2,554,000, $2,284,000, and $1,853,000,
respectively.
The following table summarizes TFB's loan loss experience for each of the last
five years ended December 31, 2002, 2001, 2000, 1999, and 1998, respectively:
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(In Thousands)
Year Ended December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------- -------------
Allowance for Loan Losses, January 1 $2,857 $2,554 $2,284 $1,853 $1,655
------------ ------------ ------------ ------------- -------------
Loans Charged-Off:
Commercial and
industrial 135 91 247 217 108
Real estate-construction
and development -- -- 4 -- --
Real estate-commercial 65 -- -- -- --
Real estate-residential -- 100 20 -- 40
Consumer 141 86 171 110 223
------------ ------------ ------------ ------------- -------------
Total Loans Charged-Off $ 341 $ 277 $ 442 $ 327 $ 371
------------ ------------ ------------ ------------- -------------
Recoveries:
Commercial and
industrial 18 193 45 18 6
Real estate-construction
and development -- -- -- -- --
Real estate-commercial -- -- -- -- --
Real estate-residential 14 -- 177 4 --
Consumer 16 37 33 41 29
------------ ------------ ------------ ------------- -------------
Total Recoveries $ 48 $ 230 $ 255 $ 63 $ 35
------------ ------------ ------------ ------------- -------------
Net Charge-Offs $ 293 $ 47 $ 187 $ 264 $ 336
------------ ------------ ------------ ------------- -------------
Provision for Loan Losses $ 346 $ 350 $ 457 $ 695 $ 534
------------ ------------ ------------ ------------- -------------
Allowance for Loan Losses, December 31 $2,910 $2,857 $2,554 $2,284 $1,853
============ ============ ============ ============= =============
Ratio of Net Charge-Offs
to Average Loans: 0.14% 0.02% 0.10% 0.15% 0.23%
============ ============ ============ ============= =============
26
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES. The following table allocates the
allowance for loan losses at December 31, 2002, 2001, 2000, 1999, and 1998 to
each loan category. The allowance has been allocated according to the amount
deemed to be reasonably necessary to provide for the possibility of losses being
incurred within the following categories of loans at the dates indicated,
although the entire allowance balance is available to absorb any actual
charge-offs that may occur. During 2001, TFB refined its policies, guidelines,
and methods for determining the allowance for loan losses, and allocating the
allowance among various loan categories. Greater weight was given to the loss
history by loan category, prolonged changes in portfolio delinquency trends by
loan category, and changes in economic trends. As a result, the allocation of
the allowance for loan losses in 2002 and 2001 may not be comparable to prior
periods.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
(In Thousands)
2002 2001 2000
---------------------------- ----------------------------- -----------------------------
Allowance Percentage Allowance Percentage Allowance Percentage
for Loan of Total for Loan of Total for Loan of Total
Losses Loans Losses Loans Losses Loans
------------ ------------ ------------ ------------ ------------ ------------
Commercial $1,663 9.41% $1,982 7.21% $ 950 8.55%
Agricultural -- 0.00% -- 0.00% -- 0.00%
Real Estate:
Construction -- 4.93% -- 8.01% 25 6.46%
Secured by Farmland -- 1.12% -- 1.06% -- 0.19%
1-4 Family Residential 262 35.36% 448 34.56% 300 36.98%
Commercial Real Estate 364 28.61% -- 29.88% 50 26.90%
Consumer 621 16.33% 427 16.45% 1,229 17.99%
All Other Loans -- 4.24% -- 2.83% -- 2.93%
------------ ------------ ------------ ------------ ------------ ------------
$2,910 100.00% $2,857 100.00% $2,554 100.00%
============ ============ ============ ============ ============ ============
1999 1998
---------------------------- -----------------------------
Allowance Percentage Allowance Percentage
for Loan of Total for Loan of Total
Losses Loans Losses Loans
------------ ------------ ------------ ------------
Commercial $ 895 9.08% $ 714 10.29%
Agricultural -- 0.00% -- 0.00%
Real Estate:
Construction -- 6.39% -- 5.04%
Secured by Farmland -- 0.49% -- 0.71%
1-4 Family Residential 264 35.32% 160 32.47%
Commercial Real Estate -- 27.74% -- 30.27%
Consumer 1,125 18.38% 979 18.41%
All Other Loans -- 2.65% -- 2.81%
------------ ------------ ------------ ------------
$2,284 100.06% $1,853 100.00%
============ ============ ============ ============
27
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
The following is a schedule of maturities and sensitivities of loans subject to
changes in interest rates as of December 31, 2002:
MATURITY SCHEDULE OF SELECTED LOANS
(In Thousands)
1 Year
WIthin Within After
1 Year 5 Years 5 Years Total
------------ ------------ ------------ ------------
Commercial and industrial loans $ 9,541 $ 7,872 $2,973 $20,386
Construction Loans 4,577 5,406 702 10,685
------------ ------------ ------------ ------------
$14,118 $13,278 $3,675 $31,071
============ ============ ============ ============
For maturities over one year:
Floating rate loans $ 1,461 $3,013 $ 4,474
Fixed rate loans 11,817 662 $12,479
------------ ------------ ------------
$13,278 $3,675 $16,953
============ ============ ============
INVESTMENT PORTFOLIO
At December 31, 2002, 2001 and 2000, the carrying values of the major
classifications of securities were as follows:
INVESTMENT PORTFOLIO
(In Thousands)
Available for Sale (1) Held to Maturity (1)
------------------------------------------- ----------------------------------------
2002 2001 2000 2002 2001 2000
------------ ----------- ------------ ------------ ----------- -----------
U.S. Treasury and other U.S.
Government agencies and
corporations $58,957 $26,844 $ 9,559 $0 $0 $1,589
Obligations of states and political
subdivisions 1,721 3,103 1,657 -- -- 2,391
Corporate Bonds 4,361 5,229 -- -- -- --
Mutual funds 5,067 -- -- -- -- --
Restricted investment - Federal
Home Loan Bank stock 1,029 1,150 1,150 -- -- --
FHLMC preferred stock 480 460 488 -- -- --
Other securities 122 122 122 -- -- --
------------ ----------- ------------ ------------ ----------------------
Total $71,737 $36,908 $12,976 $0 $0 $3,980
------------ ----------- ------------ ------------ ----------------------
(1) Amounts for held-to-maturity securities are based on amortized cost. Amounts
for available-for-sale securities are based on fair value.
28
MATURITY OR NEXT RATE ADJUSTMENT DATE
The following is a schedule of estimated maturities or next rate adjustment date
and related weighted average yields of securities at December 31, 2002:
MATURITY DISTRIBUTION AND YIELDS OF SECURITIES
(in Thousands)
Due in one year Due after 1 Due after 5
or less through 5 years through 10 years
--------------------------- -------------------------- ---------------------------
Amount Yield Amount Yield Amount Yield
------------ ------------- ------------ ------------ ------------ -------------
SECURITIES AVAILABLE FOR SALE:
Obligations of U.S. government
corporations and agencies $25,597 3.47% $26,643 3.86% $6,376 4.78%
Corporate bonds 3,321 5.43% 1,040 5.44% --
Mutual bond fund 5,067 2.60% -- --
Other taxable securities -- -- --
------------ ------------ ------------
Total taxable $33,985 $27,683 $6,376
Obligations of states and political
subdivisions, tax-exempt 487 4.31% 210 2.56% --
------------ ------------ ------------
TOTAL SECURITIES: $34,472 $27,893 $6,376
============ ============ ============
Due after 10 years
and Equity Securities Total
--------------------------- --------------------------
Amount Yield Amount Yield
------------ ------------- ------------ ------------
SECURITIES AVAILABLE FOR SALE:
Obligations of U.S. government
corporations and agencies $341 6.66% $58,957 3.79%
Corporate bonds -- 4,361 5.44%
Mutual bond fund -- 5,067 2.60%
Other taxable securities 1,631 4.96% 1,631 4.96%
------------ ------------
Total taxable $1,972 $70,016
Obligations of states and political
subdivisions, tax-exempt 1,024 5.34% 1,721 4.77%
------------ ------------
TOTAL SECURITIES: $2,996 $71,737
============ ============
Yields on tax-exempt securities have been computed on a tax-equivalent basis
using a federal tax rate of 34%.
29
DEPOSITS
The average daily amounts of deposits and rates paid on deposits is summarized
for the periods indicated in the following table:
DEPOSITS AND RATES PAID (IN THOUSANDS)
December 31,
----------------------------------------------------------------------------------------
2002 2001 2000
--------------------------- ---------------------------- ----------------------------
Amount Rate Amount Rate Amount Rate
------------ ------------ ------------ ------------- ------------- ------------
Noninterest-bearing $ 51,016 $ 43,628 $ 37,123
------------ ------------ -------------
Interest-bearing:
NOW accounts 46,403 0.36% 39,980 0.66% 37,201 1.12%
Money market accounts 53,348 1.75% 36,307 2.89% 34,969 3.39%
Regular savings accounts 37,833 1.16% 32,137 2.16% 32,869 2.68%
Time deposits 70,179 3.81% 76,469 5.57% 53,001 5.11%
------------ ------------ -------------
Total interest-bearing 207,763 2.02% 184,893 3.39% 158,040 3.28%
-------------
Total deposits $258,779 $228,521 $195,163
============ ============ =============
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
The following is a schedule of maturities of time deposits in amounts of
$100,000 or more as of December 31, 2002:
[Insert Maturities of Deposit table -can be found on same spreadsheet as above
table, Deposits and Rates]
MATURITIES OF CERTIFICATES OF DEPOSIT
AND OTHER TIME DEPOSITS OF $100,000 AND MORE
(In Thousands)
Within Three to Six to One to Over
Three Six Twelve Four Four
Months Months Months Years Years Total
------------ ------------ ------------ ------------- ------------- ------------
(Dollars in thousands)
At December 31, 2002 $2,993 $3,739 $11,041 $3,908 $1,344 $23,025
============ ============ ============ ============= ============= ============
BORROWED FUNDS
LONG-TERM BORROWINGS. Amounts and weighted average rates for long-term
borrowings for 2002, 2001 and 2000 are as follows:
BORROWED FUNDS (IN THOUSANDS)
December 31,
-------------------------------------------------------------------------
2002 2001 2000
------------------ ----------------- -----------------
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
FHLB Advances $15,000 4.64% $15,000 4.64% $13,000 5.27%
SHORT-TERM BORROWINGS. This information is not required, as the average amount
of borrowings during the period did not exceed 30% of shareholders' equity.
30
CAPITAL
Bankshares and TFB are subject to various regulatory capital requirements
administered by banking agencies. Failure to meet minimum capital requirements
can trigger certain mandatory and discretionary actions by regulators that could
have a direct material effect on Bankshares' financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
Bankshares and TFB must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices. Bankshares' and
TFB's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Bankshares and TFB to maintain minimum amounts and ratios (set forth in
the table below) of Total and Tier I Capital (as defined in the regulations) to
risk-weighted assets (as defined in the regulations), and of Tier I Capital to
average assets (as defined in the regulations). Management believes, as of
December 31, 2002 that Bankshares and TFB more than satisfy all capital adequacy
requirements to which they are subject.
Bankshares and TFB exceeded their regulatory capital ratios, as set forth in the
following table:
RISK BASED CAPITAL RATIOS (IN THOUSANDS)
December 31,
-------------------------------------
2002 2001
------------ -------------
Tier 1 Capital:
Shareholders' Equity $26,431 $24,157
Less: Unrealized gain on securities
available for sale (670) (227)
Less: Intangible assets, net (109) --
Plus: Company-obligated madatorily
redeemable capital securities 4,000 --
------------ -------------
Total Tier 1 Capital 29,652 23,930
Tier 2 Capital:
Allowable Allowance for Loan Losses 2,602 2,497
Total Capital: 32,254 $26,654
------------ -------------
Risk Weighted Assets: $207,875 $199,414
============ =============
Risk Based Capital Ratios:
Tier 1 to Risk Weighted Assets 14.26% 12.00%
Total Capital to Risk Weighted Assets 15.52% 13.37%
31
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and the accompanying notes presented
elsewhere in this document, have been prepared in accordance with accounting
principles generally accepted in the United States of America, which require the
measurement of financial position and operating results in terms of historical
dollars without considering the change in the relative purchasing power of money
over time and due to inflation. Unlike most industrial companies, virtually all
the assets and liabilities of Bankshares and TFB are monetary in nature. The
impact of inflation is reflected in the increased cost of operations. As a
result, interest rates have a greater impact on our performance than inflation
does. Interest rates do not necessarily move in the same direction or to the
same extent as the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
For information regarding recent accounting pronouncements and their effect on
Bankshares, see "Recent Accounting Pronouncements" in Note 1 of the Notes to
Consolidated Financial Statements contained herein.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
An important component of both earnings performance and liquidity is management
of interest rate sensitivity. Interest rate sensitivity reflects the potential
effect on net interest income and economic value of equity from a change in
market interest rates. TFB is subject to interest rate sensitivity to the degree
that its interest-earning assets mature or reprice at different time intervals
than its interest-bearing liabilities. However, TFB is not subject to the other
major categories of market risk such as foreign currency exchange rate risk or
commodity price risk.
TFB uses a number of tools to manage its interest rate risk, including
simulating net interest income under various scenarios, monitoring the present
value change in equity under the same scenarios, and monitoring the difference
or gap between rate sensitive assets and rate sensitive liabilities over various
time periods. Management believes that rate risk is best measured by simulation
modeling.
The earnings simulation model forecasts annual net income under a variety of
scenarios that incorporate changes in the absolute level of interest rates,
changes in the shape of the yield curve, and changes in interest rate
relationships. Management evaluates the effect on net interest income and
present value equity under varying market rate assumptions.
TFB monitors exposure to instantaneous changes in rates of up to 200 basis
points up or down over a rolling 12-month period. TFB's policy limit for the
maximum negative impact on net interest income and change in equity from
instantaneous changes in interest rates of 200 basis points over 12 months is
15% and 20%, respectively. Management has maintained a risk position well within
these guideline levels during 2002.
32
The following tables present TFB's market value changes in equity under various
rate scenarios as of December 31, 2002 and 2001.
MARKET RISK
2002 Percentage Market Minus Current Plus Market Percentage
Change Value Change 200 pts Fair Value 200 pts Value Change Change
Federal funds sold 0.00% -- $ 4,900 $ 4,900 $ 4,900 -- 0.00%
Securities 5.87% 76,176 71,950 67,772 (4,178) -5.81%
Loans receivable 6.91% 14,883 230,279 215,396 206,983 (8,413) -3.91%
--------------- ----------- ------------ ----------- --------------
Total rate sensitive assets 6.54% 19,109 311,355 292,246 279,655 (12,591) -4.31%
Other assets 0.00% -- 30,952 30,952 30,952 -- 0.00%
--------------- ----------- ------------ ----------- --------------
Total assets 5.91% $ 19,109 $342,307 $ 323,198 $ 310,607 $ (12,591) -3.90%
============ =============== =========== ============ =========== ============== ===========
Demand deposits 5.53% $ 3,051 $ 58,226 $ 55,175 $ 52,405 $ (2,770) -5.02%
Rate-bearing deposits 3.74% 7,655 212,502 204,847 197,882 (6,965) -3.40%
Borrowed funds 14.03% 2,856 23,215 20,359 17,902 (2,457) -12.07%
Other liabilities 0.00% -- 2,400 2,400 2,400 -- 0.00%
--------------- ----------- ------------ ----------- --------------
Total liabilities 4.80% 13,562 296,343 282,781 270,589 (12,192) -4.31%
Present Value Equity 13.72% 5,547 45,964 40,417 40,018 (399) -0.99%
--------------- ----------- ------------ ----------- --------------
Total liabilities and equity 5.91% $ 19,109 $342,307 $ 323,198 $ 310,607 $ (12,591) -3.90%
============ =============== =========== ============ =========== ============== ===========
2001 Percentage Market Minus Current Plus Market Percentage
(Dollars in thousands) Change Value Change 200 pts Fair Value 200 pts Value Change Change
Federal funds sold 0.00% -- $ 15,421 $ 15,421 $ 15,419 $ (2) -0.01%
Securities 8.83% 3,257 40,165 36,908 34,796 (2,112) -5.72%
Loans receivable 4.94% 10,549 224,237 213,688 203,739 (9,949) -4.66%
--------------- ----------- ------------ ----------- --------------
Total rate sensitive assets 5.19% 13,806 279,823 266,017 253,954 (12,063) -4.53%
Other assets 0.00% -- 24,801 24,801 24,801 -- 0.00%
--------------- ----------- ------------ ----------- --------------
Total assets 4.75% $ 13,806 $304,624 $ 290,818 $ 278,755 $ (12,063) -4.15%
============ =============== =========== ============ =========== ============== ===========
Demand deposits 4.06% $ 1,877 $ 48,152 $ 46,275 $ 43,528 $ (2,747) -5.94%
Rate-bearing deposits 3.27% 6,458 204,005 197,547 190,242 (7,305) -3.70%
Borrowed funds 3.01% 454 15,514 15,060 14,620 (440) -2.92%
Other liabilities 0.00% -- 2,791 2,791 2,791 -- 0.00%
--------------- ----------- ------------ ----------- --------------
Total liabilities 3.36% 8,789 270,462 261,673 251,181 (10,492) -4.01%
Present Value Equity 17.21% 5,017 34,162 29,145 27,574 (1,571) -5.39%
--------------- ----------- ------------ ----------- --------------
Total liabilities and equity 4.75% $ 13,806 $304,624 $ 290,818 $ 278,755 $ (12,063) -4.15%
============ =============== =========== ============ =========== ============== ===========
33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONTENTS
PAGE
INDEPENDENT AUDITOR'S REPORT ON THE
CONSOLIDATED FINANCIAL STATEMENTS 35
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets 36
Consolidated statements of income 37 and 38
Consolidated statements of cash flows 39 and 40
Consolidated statements of changes
in shareholders' equity 41
Notes to consolidated financial statements 42-67
34
[GRAPHIC OMITTED]
Yount, Hyde, & Barbour, P.C.
Certified Public Accountants
and Consultants
INDEPENDENT AUDITOR'S REPORT
To the Shareholders and Directors of
Fauquier Bankshares, Inc. and Subsidiaries
Warrenton, Virginia
We have audited the accompanying consolidated balance sheets of
Fauquier Bankshares, Inc. and subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of income, changes in shareholders' equity
and cash flows for the years ended December 31, 2002, 2001 and 2000. These
financial statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Fauquier Bankshares, Inc. and subsidiaries as of December 31, 2002 and 2001, and
the results of their operations and their cash flows for the years ended
December 31, 2002, 2001 and 2000, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Yount, Hyde & Barbour, P.C.
- -------------------------------
Winchester, Virginia
January 10, 2003
35
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
ASSETS 2002 2001
------------ ------------
Cash and due from banks $ 19,824,120 $ 14,408,495
Interest-bearing deposits in other banks 212,960 352,536
Federal funds sold 4,900,000 15,421,000
Securities, at fair value 71,736,633 36,907,864
Loans, net of allowance for loan losses of $2,909,607 in 2002
and $2,856,743 in 2001 213,697,948 207,452,738
Bank premises and equipment, net 6,468,205 6,335,708
Accrued interest receivable 1,739,638 1,590,282
Other assets 2,919,978 2,733,384
------------ ------------
Total assets $321,499,482 $285,202,007
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing $ 60,181,808 $ 50,659,242
Interest-bearing 213,486,663 193,087,800
------------ ------------
Total deposits 273,668,471 243,747,042
Federal Home Loan Bank advances 15,000,000 15,000,000
Company-obligated mandatorily redeemable capital securities 4,000,000 --
Dividends payable 363,447 318,356
Other liabilities 2,036,399 1,979,210
Commitments and contingent liabilities -- --
============ ============
Total liabilities 295,068,317 261,044,608
============ ============
SHAREHOLDERS' EQUITY
Common stock, par value, $3.13 per share; 8,000,000 shares authorized;
issued and outstanding, 2002, 3,304,066 shares; 2001, 1,675,559 shares 10,341,726 5,244,500
Retained earnings 15,419,307 18,685,761
Accumulated other comprehensive income 670,132 227,138
------------ ------------
Total shareholders' equity 26,431,165 24,157,399
------------ ------------
Total liabilities and shareholders' equity $321,499,482 $285,202,007
============ ============
See Notes to Consolidated Financial Statements.
36
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For Each of the Three Years in the Period Ended December 31, 2002
2002 2001 2000
------------ ------------ ------------
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $ 17,198,498 $ 17,617,424 $ 16,584,470
Interest on investment securities:
Taxable interest income -- -- 142,788
Interest income exempt from federal income taxes -- -- 103,808
Interest and dividends on securities available for sale:
Taxable interest income 1,795,511 1,174,762 539,331
Interest income exempt from federal income taxes 108,218 154,816 17,778
Dividends 194,587 159,089 158,761
Interest on federal funds sold 196,643 675,574 450,492
Interest on deposits in other banks 2,571 2,864 5,251
------------ ------------ ------------
Total interest and dividend income 19,496,028 19,784,529 18,002,679
------------ ------------ ------------
INTEREST EXPENSE
Interest on deposits 4,206,623 6,263,296 5,188,371
Distribution on capital securities of subsidiary trust 170,379 -- --
Interest on Federal Home Loan Bank advances 705,160 957,414 895,984
------------ ------------ ------------
Total interest expense 5,082,162 7,220,710 6,084,355
------------ ------------ ------------
Net interest income 14,413,866 12,563,819 11,918,324
Provision for loan losses 346,250 350,000 457,498
------------ ------------ ------------
Net interest income after provision for loan losses 14,067,616 12,213,819 11,460,826
------------ ------------ ------------
NONINTEREST INCOME
Wealth management income 694,442 704,681 598,520
Service charges on deposit accounts 2,131,445 1,711,222 1,483,245
Other service charges, commissions and fees 978,626 824,783 750,845
Non-loan charge-off recovery -- 542,320 --
Gain (loss) on securities available for sale 33,914 -- (110,830)
Other operating income 62,042 53,090 8,969
------------ ------------ ------------
Total noninterest income 3,900,469 3,836,096 2,730,749
------------ ------------ ------------
NONINTEREST EXPENSES
Salaries and employees' benefits 5,884,134 4,851,413 4,108,482
Net occupancy expense of premises 731,333 591,730 467,111
Furniture and equipment 1,049,280 861,427 834,915
Other operating expenses 4,631,779 4,633,130 4,254,838
------------ ------------ ------------
Total noninterest expenses 12,296,526 10,937,700 9,665,346
------------ ------------ ------------
Income before income taxes 5,671,559 5,112,215 4,526,229
Income tax expense 1,741,743 1,596,781 1,429,601
------------ ------------ ------------
Net income $ 3,929,816 $ 3,515,434 $ 3,096,628
============ ============ ============
See Notes to Consolidated Financial Statements.
37
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Continued)
For Each of the Three Years in the Period Ended December 31, 2002
2002 2001 2000
--------- --------- ---------
EARNINGS PER SHARE, basic $ 1.18 $ 1.03 $ 0.88
======== ======== ========
EARNINGS PER SHARE, assuming dilution $ 1.14 $ 1.01 $ 0.88
======== ======== ========
See Notes to Consolidated Financial Statements.
38
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Each of the Three Years in the Period Ended December 31, 2002
2002 2001 2000
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,929,816 $ 3,515,434 $ 3,096,628
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 941,787 747,886 747,145
Provision for loan losses 346,250 350,000 457,498
Deferred tax (benefit) (123,229) (77,080) (156,891)
(Gain) loss on securities available for sale (33,914) -- 110,830
(Gain) loss on other real estate -- -- (7,739)
(Gain) on sale of premises and equipment (7,006) (65) (1,230)
Tax benefit of nonqualified options exercised (17,114) -- --
Amortization of security premiums and
(accretion) of discounts, net 487,583 93,021 (63,001)
Changes in assets and liabilities:
(Increase) in other assets (423,816) (223,769) (1,078,253)
Increase (decrease) in other liabilities 57,189 (62,348) 576,732
------------ ------------ ------------
Net cash provided by operating activities 5,157,546 4,343,079 3,681,719
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale 1,033,650 -- 826,979
Proceeds from maturities, calls and principal
payments of investment securities -- -- 1,401,804
Proceeds from maturities, calls and principal
payments of securities available for sale 22,614,625 11,960,187 2,422,512
Purchase of securities available for sale (58,259,510) (31,531,332) (2,447,894)
Proceeds from sale of premises and equipment 7,006 65 1,230
Proceeds from sale of other real estate owned -- -- 355,561
Purchase of premises and equipment (1,074,284) (1,826,406) (410,085)
Purchase of other investment -- -- (749,000)
Improvements to other real estate owned -- -- (2,774)
Net (increase) in loans (6,591,460) (9,923,858) (17,178,114)
------------ ------------ ------------
Net cash (used in) investing activities (42,269,973) (31,321,344) (15,779,781)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand deposits, NOW accounts
and saving accounts 28,437,904 36,585,184 (2,582,805)
Net increase (decrease) in certificates of deposit 1,483,525 (4,941,401) 27,413,390
Proceeds from issuance of capital securities 4,000,000 -- --
Federal Home Loan Bank advances -- 10,000,000 --
Federal Home Loan Bank principal repayments -- (8,000,000) (10,000,000)
Cash dividends paid (1,310,949) (1,194,739) (1,092,198)
Issuance of common stock 307,520 28,309 22,932
Acquisition of common stock (1,050,524) (895,941) (1,069,839)
------------ ------------ ------------
Net cash provided by financing activities 31,867,476 31,581,412 12,691,480
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents (5,244,951) 4,603,147 593,418
CASH AND CASH EQUIVALENTS
Beginning 30,182,031 25,578,884 24,985,466
------------ ------------ ------------
Ending $ 24,937,080 $ 30,182,031 $ 25,578,884
============ ============ ============
See Notes to Consolidated Financial Statements.
39
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
For Each of the Three Years in the Period Ended December 31, 2002
2002 2001 2000
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 5,220,286 $ 7,371,938 $ 5,704,615
=========== =========== ===========
Income taxes $ 1,709,500 $ 1,872,500 $ 1,467,000
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES
Other real estate acquired in settlement of loans $ -- $ -- $ 345,048
=========== =========== ===========
Unrealized gain (loss) on securities available for sale, net $ 671,202 $ 473,759 $ 427,822
=========== =========== ===========
Transfer of securities from held to maturity to available for sale $ -- $ 3,980,765 $ --
=========== =========== ===========
See Notes to Consolidated Financial Statements.
40
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For Each of the Three Years in the Period Ended December 31, 2002
ACCUMULATED
OTHER
COMPRE- COMPRE-
COMMON CAPITAL RETAINED HENSIVE HENSIVE
STOCK SURPLUS EARNINGS INCOME (LOSS) INCOME TOTAL
------------ ------------ ------------ ------------- ------------ ------------
BALANCE, DECEMBER 31, 1999 $ 5,552,736 $ -- $ 16,019,525 $ (367,906) $ 21,204,355
Comprehensive income:
Net income -- -- 3,096,628 -- $ 3,096,628 3,096,628
Other comprehensive income net of tax:
Unrealized holding gains on securities
available for sale, net of deferred
income taxes of $107,777 209,215
Add reclassification adjustment net of
income tax benefit of $37,682 73,148
------------
Other comprehensive income, net of tax -- -- -- 282,363 282,363 282,363
------------
Total comprehensive income -- -- -- -- $ 3,378,991 --
============
Cash dividends -- -- (1,117,500) -- (1,117,500)
Acquisition of 63,120 shares of
common stock (197,566) -- (872,273) -- (1,069,839)
Issuance of common stock 3,988 -- 18,944 -- 22,932
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2000 5,359,158 -- 17,145,324 (85,543) 22,418,939
Comprehensive income:
Net income -- -- 3,515,434 -- $ 3,515,434 3,515,434
Other comprehensive income net of tax:
Unrealized holding gains on securities
available for sale, net of deferred
income taxes of $161,078 -- -- -- 312,681 312,681 312,681
------------
Total comprehensive income $ 3,828,115 --
============
Cash dividends -- -- (1,222,023) -- (1,222,023)
Acquisition of 38,958 shares of
common stock (121,938) -- (774,003) -- (895,941)
Issuance of common stock 4,150 -- 15,409 -- 19,559
Exercise of stock options 3,130 -- 5,620 -- 8,750
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2001 5,244,500 -- 18,685,761 227,138 24,157,399
Comprehensive income:
Net income -- -- 3,929,816 -- $ 3,929,816 3,929,816
Other comprehensive income net of tax:
Unrealized holding gains on securities
available for sale, net of deferred
income taxes of $239,740 465,377
Less reclassification adjustment, net of
income tax expense of $11,531 (22,383)
------------
Other comprehensive income, net of tax -- -- -- 442,994 442,994 442,994
============
Total comprehensive income -- -- -- -- $ 4,372,810 --
============
100% stock dividend 5,185,020 -- (5,185,020) -- --
Cash dividends -- -- (1,356,040) -- (1,356,040)
Acquisition of 54,259 shares of
common stock (169,832) -- (880,692) -- (1,050,524)
Issuance of common stock 5,547 -- 37,424 -- 42,971
Exercise of stock options 76,491 -- 188,058 -- 264,549
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2002 $ 10,341,726 $ -- $ 15,419,307 $ 670,132 $ 26,431,165
============ ============ ============ ============ ============
See Notes to Consolidated Financial Statements.
41
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Each of the Three Years in the Period Ended December 31, 2002
NOTE 1. NATURE OF BANKING ACTIVITIES AND SIGNIFICANT ACCOUNTING POLICIES
Fauquier Bankshares, Inc. and subsidiaries (the Corporation)
grant commercial, financial, agricultural, residential and
consumer loans to customers in Virginia. The loan portfolio is
well diversified and generally is collateralized by assets of the
customers. The loans are expected to be repaid from cash flows or
proceeds from the sale of selected assets of the borrowers.
The accounting and reporting policies of the Corporation conform
to accounting principles generally accepted in the United States
of America and to the reporting guidelines prescribed by
regulatory authorities. The following is a description of the
more significant of those policies and practices.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts
of Fauquier Bankshares, Inc. and its wholly-owned
subsidiaries, The Fauquier Bank, of which Fauquier Bank
Services, Inc. is its sole subsidiary and Fauquier Statutory
Trust I. In consolidation, significant intercompany accounts
and transactions have been eliminated.
SECURITIES
Debt securities that management has the positive intent and
ability to hold to maturity are classified as "held to
maturity" and recorded at amortized cost. Securities not
classified as held to maturity, including equity securities
with readily determinable fair values, are classified as
"available for sale" and recorded at fair value, with
unrealized gains and losses excluded from earnings and
reported in other comprehensive income.
Purchase premiums and discounts are recognized in interest
income using the interest method over the terms of the
securities. Declines in the fair value of held to maturity
and available for sale securities below their cost that are
deemed to be other than temporary are reflected in earnings
as realized losses. Gains and losses on the sale of
securities are recorded on the trade date and are determined
using the specific identification method.
LOANS
The Corporation, through its banking subsidiary, grants
mortgage, commercial and consumer loans to customers. A
substantial portion of the loan portfolio is represented by
commercial and residential mortgage loans. The ability of
the Corporation's debtors to honor their contracts is
dependent upon the real estate and general economic
conditions in the Corporation's market area.
Loans that management has the intent and ability to hold for
the foreseeable future or until maturity or pay-off
generally are reported at their outstanding unpaid principal
balances adjusted for the allowance for loan losses, and any
deferred fees or costs on originated loans. Interest income
is accrued on the unpaid principal balance. Loan origination
fees, net of certain direct origination costs, are deferred
and recognized as an adjustment of the related loan yield
using the interest method.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accrual of interest on mortgage and commercial loans is
discontinued at the time the loan is 90 days delinquent
unless the credit is well-secured and in the process of
collection. Installment loans are typically charged off no
later than 180 days past due. In all cases, loans are placed
on nonaccrual or charged-off at an earlier date if
collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are
placed on nonaccrual or charged-off is reversed against
interest income. The interest on these loans is accounted
for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to
accrual status when all the principal and interest amounts
contractually due are brought current and future payments
are reasonably assured.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan
losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility
of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular
basis by management and is based upon management's periodic
review of the collectibility of the loans in light of
historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's
ability to repay, estimated value of any underlying
collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more
information becomes available.
The allowance for loan losses has three basic components:
the specific allowance, the formula allowance and the
unallocated allowance. Each of these components is
determined based upon estimates that can and do change when
the actual events occur.
The specific allowance is used to individually allocate an
allowance for larger balance, non-homogeneous loans. The
specific allowance uses various techniques to arrive at an
estimate of loss. First, analysis of the borrower's overall
financial condition, resources and payment record; the
prospects for support from financial guarantors; and the
fair market value of collateral are used to estimate the
probability and severity of inherent losses. Additionally,
the migration of historical default rates and loss
severities, internal risk ratings, industry and market
conditions and trends, and other environmental factors are
considered.
The formula allowance is used for estimating the loss on
pools of smaller-balance, homogeneous loans; including
one-to-four family mortgage loans, installment loans, other
consumer loans, as well as outstanding loan commitments.
Also, a formula allowance is used for the remaining pool of
larger balance, non-homogeneous loans which were not
allocated a specific allowance upon their review. The
formula allowance begins with estimates of probable losses
inherent in the homogeneous portfolio based upon various
statistical analyses. These include analysis of historical
and peer group delinquency and credit loss experience,
together with analyses that reflect current trends and
conditions. Trends and changes in the volume and term of
loans, changes in the credit process and/or lending policies
and procedures, and an evaluation of overall credit quality
are considered. The formula allowance uses a historical loss
view as an indicator of future losses and, as a result,
could differ from the loss incurred in the future. However,
since the history is regularly updated with the most recent
loss information, the errors that might otherwise occur are
mitigated.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unallocated allowance captures losses that are
attributable to various economic events, industry or
geographic sectors whose impact on the portfolio have
occurred but have yet to be recognized in either the formula
or specific allowances. In addition, an unallocated reserve
is maintained to recognize the imprecision in estimating and
measuring inherent losses on individual loans or pools of
loans.
A loan is considered impaired when, based on current
information and events, it is probable that the Corporation
will be unable to collect the scheduled payments of
principal or interest when due according to the contractual
terms of the loan agreement. Factors considered by
management in determining impairment include payment status,
collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans
that experience insignificant payment delays and payment
shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan
and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record,
and the amount of the shortfall in relation to the principal
and interest owed. Impairment is measured on a loan-by-loan
basis for commercial and construction loans by either the
present value of expected future cash flows discounted at
the loan's effective interest rate, the loan's obtainable
market price, or the fair value of the collateral if the
loan is collateral dependent.
Large groups of smaller balance homogeneous loans are
collectively evaluated for impairment. Accordingly, the
Corporation does not separately identify individual consumer
and residential loans for impairment disclosures.
BANK PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated
depreciation and amortization. Premises and equipment are
depreciated over their estimated useful lives; leasehold
improvements are amortized over the lives of the respective
leases or the estimated useful life of the leasehold
improvement, whichever is less. Depreciation and
amortization are recorded on the accelerated and
straight-line methods.
Costs of maintenance and repairs are charged to expense as
incurred. Costs of replacing structural parts of major units
are considered individually and are expensed or capitalized
as the facts dictate.
INCOME TAXES
Deferred income tax assets and liabilities are determined
using the balance sheet method. Under this method, the net
deferred tax asset or liability is determined based on the
tax effects of the temporary differences between the book
and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax
rates and laws.
DEFINED BENEFIT PLAN
The Corporation has a pension plan for its employees.
Benefits are generally based upon years of service and the
employees' compensation. The Corporation's policy is to fund
the maximum allowable contribution in accordance with the
funding provisions of the Employee Retirement Act.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
EARNINGS PER SHARE
Basic earnings per share represents income available to
common shareholders divided by the weighted-average number
of common shares outstanding during the period. Diluted
earnings per share reflects additional common shares that
would have been outstanding if dilutive potential common
shares had been issued, as well as any adjustment to income
that would result from the assumed issuance. Potential
common shares that may be issued by the Corporation relate
solely to outstanding stock options, and are determined
using the treasury method.
STOCK-BASED COMPENSATION
At December 31, 2002, the Corporation has a stock-based
compensation plan, which is described more fully in Note 12.
The Corporation accounts for the plan under the recognition
and measurement principles of APB Opinion 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 the plan had an
exercise price equal to the market value of the underlying
common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share
for the Corporation had the fair value recognition
provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," to stock-based compensation.
December 31,
-----------------------------------------------
2002 2001 2000
------------ ------------ ------------
Net income, as reported $ 3,929,816 $ 3,515,434 $ 3,096,628
Deduct: total stock-based employee compensation
expense determined based on fair
value method of awards, net of tax (296,042) (238,520) (187,882)
------------ ------------- ------------
Pro forma net income $ 3,633,774 $ 3,276,914 $ 2,908,746
============ ============= ============
Earnings per share:
Basic - as reported $ 1.18 $ 1.03 $ 0.88
============ ============= ============
Basic - pro forma $ 1.10 $ 0.96 $ 0.83
============ ============= ============
Diluted - as reported $ 1.14 $ 1.01 $ 0.88
============ ============= ============
Diluted - pro forma $ 1.05 $ 0.94 $ 0.82
============ ============= ============
WEALTH MANAGEMENT SERVICES DIVISION
Securities and other property held by the Wealth Management
Services Division in a fiduciary or agency capacity are not
assets of the Corporation and are not included in the
accompanying consolidated financial statements.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, amounts due
from banks and federal funds sold. Generally, federal funds
are purchased and sold for one-day periods.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OTHER REAL ESTATE
Assets acquired through, or in lieu of, loan foreclosure are
held for sale and are initially recorded at the lower of the
loan balance or fair value at the date of foreclosure,
establishing a new cost basis. Subsequent to foreclosure,
valuations are periodically performed by management and the
assets are carried at the lower of carrying amount or fair
value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are
included in other operating expenses.
USE OF ESTIMATES
In preparing consolidated financial statements in conformity
with accounting principles generally accepted in the United
States of America, management is required to make estimates
and assumptions that affect the reported amounts of assets
and liabilities as of the date of the balance sheet and
reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates. Material estimates that are particularly
susceptible to significant change in the near term relate to
the determination of the allowance for loan losses, and the
valuation of foreclosed real estate and deferred tax assets.
ADVERTISING
The Corporation follows the policy of charging the costs of
advertising to expense as incurred. Advertising expenses of
$356,830, $262,886 and $258,997 were incurred in 2002, 2001
and 2000, respectively.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period
balances to conform to the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2001, the American Institute of Certified Public
Accountants ("AICPA") issued Statement of Position 01-6,
"Accounting by Certain Entities (Including Entities with
Trade Receivables) That Lend to or Finance the Activities of
Others," to reconcile and conform the accounting and
financial reporting provisions established by various AICPA
industry audit guides. This Statement is effective for
annual and interim financial statements issued for fiscal
years beginning after December 15, 2001, and did not have a
material impact on the Corporation's consolidated financial
statements.
In April 2002, the Financial Accounting Standards Board
issued Statement 145, "Rescission of FASB No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections." The amendment to Statement 13 eliminates an
inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for
certain lease modifications that have economic effects that
are similar to sale-leaseback transactions. This Statement
also amends other existing authoritative pronouncements to
make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. The
provisions of this Statement related to the rescission of
Statement 4 shall be applied in fiscal years beginning after
May 15, 2002. The provisions of this Statement related to
Statement 13 are effective for transactions occurring after
May 15, 2002, with early application encouraged.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In June 2002, the Financial Accounting Standards Board
issued Statement 146, "Accounting for Costs Associated with
Exit or Disposal Activities." This Statement requires
recognition of a liability, when incurred, for costs
associated with an exit or disposal activity. The liability
should be measured at fair value. The provisions of the
Statement are effective for exit or disposal activities
initiated after December 31, 2002.
Effective January 1, 2002, the Corporation adopted Financial
Accounting Standards Board Statement No. 142, "Goodwill and
Other Intangible Assets." Accordingly, goodwill is no longer
subject to amortization over its estimated useful life, but
is subject to at least an annual assessment for impairment
by applying a fair value based test. Additionally, Statement
142 requires that acquired intangible assets (such as core
deposit intangibles) be separately recognized if the benefit
of the asset can be sold, transferred, licensed, rented, or
exchanged, and amortized over their estimated useful life.
Branch acquisition transactions were outside the scope of
the Statement and therefore any intangible asset arising
from such transactions remained subject to amortization over
their estimated useful life.
In October 2002, the Financial Accounting Standards Board
issued Statement No. 147, "Acquisitions of Certain Financial
Institutions." The Statement amends previous interpretive
guidance on the application of the purchase method of
accounting to acquisitions of financial institutions, and
requires the application of Statement No. 141, "Business
Combinations," and Statement No. 142 to branch acquisitions
if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to
transactions between two or more mutual enterprises. In
addition, the Statement amends Statement No. 144,
"Accounting for the Impairment of Long-Lived Assets," to
include in its scope core deposit intangibles of financial
institutions. Accordingly, such intangibles are subject to a
recoverability test based on undiscounted cash flows, and to
the impairment recognition and measurement provisions
required for other long-lived assets held and used.
The adoption of Statement No. 145, 146 and 147 did not have
a material impact on the Corporation's consolidated
financial statements.
The Financial Accounting Standards Board issued Statement
No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure, an amendment of Statement No.
123," in December 2002. The Statement amends Statement No.
123 to provide alternative methods of transition for a
voluntary change to the fair value based method of
accounting for stock-based employee compensation. In
addition, the Statement amends the disclosure requirements
of Statement 123 to require prominent disclosures in both
annual and interim financial statements about the method of
accounting for stock-based employee compensation and the
effect of the method used on reported results. Finally, this
Statement amends APB Opinion No. 28, "Interim Financial
Reporting," to require disclosure about the effects of stock
options in interim financial information. The amendments to
Statement No. 123 are effective for financial statements for
fiscal years ending after December 15, 2002. The amendments
to APB No. 28 are effective for financial reports containing
condensed financial statements for interim periods beginning
after December 15, 2002. Early application is encouraged for
both amendments. The Corporation continues to record stock
options under APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and has not adopted the alternative
methods allowable under Statement No. 148.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. SECURITIES
The amortized cost of securities available for sale, with
unrealized gains and losses follows:
DECEMBER 31, 2002
---------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
------------ ------------ ------------ ------------
Obligations of U.S.
Government corporations
and agencies $ 58,108,435 $ 852,327 $ (3,999) $ 58,956,763
Obligations of states and
political subdivisions 1,648,749 71,974 -- 1,720,723
Corporate bonds 4,259,676 101,505 -- 4,361,181
Mutual Funds 5,066,023 1,043 -- 5,067,066
Restricted investments:
Federal Home Loan
Bank stock 1,028,900 -- -- 1,028,900
Federal Reserve Bank
stock 72,000 -- -- 72,000
Community Bankers'
Bank stock 50,000 -- -- 50,000
FHLMC preferred
stock 487,500 -- (7,500) 480,000
------------ ------------ ------------ ------------
$ 70,721,283 $ 1,026,849 $ (11,499) $ 71,736,633
============ ============ ============ ============
DECEMBER 31, 2001
---------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
------------ ------------ ------------ ------------
Obligations of U.S.
Government corporations
and agencies $ 26,680,369 $ 202,404 $ (38,948) $ 26,843,825
Obligations of states and
political subdivisions 3,043,644 59,399 -- 3,103,043
Corporate bonds 5,080,203 148,793 -- 5,228,996
Restricted investments:
Federal Home Loan
Bank stock 1,150,000 -- -- 1,150,000
Federal Reserve Bank
stock 72,000 -- -- 72,000
Community Bankers'
Bank stock 50,000 -- -- 50,000
FHLMC preferred
stock 487,500 -- (27,500) 460,000
------------ ------------ ------------ ------------
$ 36,563,716 $ 410,596 $ (66,448) $ 36,907,864
============ ============ ============ ============
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and fair value of securities available for
sale, by contractual maturity, are shown below. Expected
maturities may differ from contractual maturities because
issuers may have the right to call or prepay obligations
without penalties.
For the years ended December 31, 2002 and 2000, proceeds from
sales of securities available for sale amounted to $1,033,650
and $826,979, respectively. Gross realized gains (losses)
amounted to $33,914 and $(110,830). The tax expense (benefit)
applicable to this net realized loss amounted to $11,531 and
$(37,682). There were no sales of securities available for sale
for the year ended December 31, 2001.
2002
----------------------------
AMORTIZED FAIR
COST VALUE
----------- -----------
Due in one year or less $ 8,640,976 $ 8,708,602
Due after one year through five years 13,601,217 13,955,199
Due after five years through ten years 9,831,625 9,958,177
Due after ten years 37,009,065 37,483,755
Equity securities 1,638,400 1,630,900
----------- -----------
$70,721,283 $71,736,633
=========== ===========
In accordance with FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities," the Corporation
transferred all held to maturity securities to the available
for sale category on January 1, 2001.
The carrying value of securities pledged to secure deposits and
for other purposes amounted to $7,023,657 and $6,281,107 at
December 31, 2002 and 2001, respectively.
NOTE 3. LOANS
A summary of the balances of loans follows:
DECEMBER 31,
---------------------------
2002 2001
------------ ------------
(Dollars in Thousands)
Mortgage loans on real estate:
Construction $ 10,685 $ 16,851
Secured by farmland 2,416 2,220
Secured by 1 to 4 family residential 76,646 72,692
Other real estate loans 62,030 62,845
Commercial and industrial loans (except
those secured by real estate) 20,386 15,154
Consumer installment loans 35,397 34,640
All other loans 9,186 5,962
-------- --------
Total loans 216,746 210,364
Less: Unearned income 138 54
Allowance for loan losses 2,910 2,857
-------- --------
Net loans $213,698 $207,453
======== ========
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4. ALLOWANCE FOR LOAN LOSSES
Analysis of the allowance for loan losses follows:
2002 2001 2000
----------- ----------- -----------
Balance at beginning of year $ 2,856,743 $ 2,554,033 $ 2,284,348
Provision charged to operating expense 346,250 350,000 457,498
Recoveries added to the allowance 47,918 230,310 254,698
Loan losses charged to the allowance (341,304) (277,600) (442,511)
----------- ----------- -----------
Balance at end of year $ 2,909,607 $ 2,856,743 $ 2,554,033
=========== =========== ===========
Information about impaired loans is as follows:
2002 2001
-------- --------
Impaired loans for which an allowance
has been provided $686,113 $776,755
Impaired loans for which no allowance
has been provided -- --
-------- --------
Total impaired loans $686,113 $776,755
======== ========
Allowance provided for impaired loans,
included in the allowance for loan losses $102,000 $200,000
======== ========
2002 2001 2000
-------- -------- --------
Average balance in impaired loans $855,926 $843,586 $ 12,804
======== ======== ========
Interest income recognized $ -- $ -- $ --
======== ======== ========
No additional funds are committed to be advanced in connection
with impaired loans.
Nonaccrual loans excluded from impaired loan disclosure under
FASB 114 amounted to $163,406, $136,134 and $121,057 at December
31, 2002, 2001 and 2000, respectively. If interest on these loans
had been accrued, such income would have approximated $6,938,
$4,066 and $3,509 for 2002, 2001 and 2000, respectively.
NOTE 5. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Corporation has granted
loans to executive officers, directors, their immediate families
and affiliated companies in which they are principal
shareholders, which amounted to $2,217,571 at December 31, 2002
and $4,652,519 at December 31, 2001. During 2002, total principal
additions were $873,258 and total principal payments were
$3,308,206.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. BANK PREMISES AND EQUIPMENT, NET
A summary of the cost and accumulated depreciation of premises
and equipment follows:
2002 2001
------------ -----------
Land $ 864,667 $ 864,667
Buildings and improvements 6,397,628 6,186,054
Furniture and equipment 8,037,305 7,063,646
Leasehold improvements 281,363 273,817
Construction in progress 101,940 259,976
----------- -----------
15,682,903 14,648,160
Less accumulated depreciation and amortization 9,214,698 8,312,452
----------- -----------
$ 6,468,205 $ 6,335,708
=========== ===========
Depreciation and amortization charged to operations totaled
$941,787, $747,886 and $747,145 in 2002, 2001 and 2000,
respectively.
NOTE 7. DEPOSITS
The aggregate amount of time deposits, in denominations of
$100,000 or more at December 31, 2002 and 2001 was $23,025,164
and $21,462,537, respectively.
At December 31, 2002, the scheduled maturities of time deposits
are as follows:
2003 $ 40,008,209
2004 13,687,597
2005 11,121,051
2006 1,048,028
2007 4,600,842
------------
$ 70,465,727
============
Overdraft demand deposits totaling $1,574,580 and $799,127 were
reclassified to loans at December 31, 2002 and 2001,
respectively.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. EMPLOYEE BENEFIT PLANS
The following tables provide a reconciliation of the changes in
the defined benefit plan's obligations and fair value of assets
over the three-year period ending December 31, 2002, computed as
of October 1st of each respective year:
2002 2001 2000
----------- ----------- -----------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning $ 4,036,939 $ 3,736,910 $ 3,339,553
Service cost 270,440 215,762 178,513
Interest cost 300,755 278,253 248,451
Actuarial (gain) loss 714,662 (115,194) 40,973
Benefits paid (145,491) (78,792) (70,580)
----------- ----------- -----------
Benefit obligation, ending $ 5,177,305 $ 4,036,939 $ 3,736,910
----------- ----------- -----------
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning $ 3,774,469 $ 4,470,263 $ 3,679,064
Actual return on plan assets (379,381) (914,910) 831,151
Employer contributions 433,036 297,908 30,628
Benefits paid (145,491) (78,792) (70,580)
----------- ----------- -----------
Fair value of plan assets, ending $ 3,682,633 $ 3,774,469 $ 4,470,263
----------- ----------- -----------
FUNDED STATUS $(1,494,672) $ (262,470) $ 733,353
Unrecognized net actuarial (gain) loss 1,483,542 65,173 (1,170,638)
Unrecognized net obligation at transition (170,803) (189,782) (208,761)
Unrecognized prior service cost 69,903 77,669 85,435
----------- ----------- -----------
Accrued benefit cost included in other liabilities $ (112,030) $ (309,410) $ (560,611)
=========== =========== ===========
The following table provides the components of net periodic
benefit cost for the plan for the years ended December 31, 2002,
2001 and 2000:
2002 2001 2000
--------- --------- ---------
COMPONENTS OF NET PERIODIC
BENEFIT COST
Service cost $ 270,440 $ 215,762 $ 178,513
Interest cost 300,755 278,253 248,451
Expected return on plan assets (324,326) (399,914) (328,706)
Amortization of prior service cost 7,766 7,766 7,766
Amortization of net obligation
at transition (18,979) (18,979) (18,979)
Recognized net actuarial gain -- (36,181) (17,063)
--------- --------- ---------
Net periodic benefit cost $ 235,656 $ 46,707 $ 69,982
========= ========= =========
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The assumptions used in the measurement of the Corporation's
benefit obligation are shown in the following table:
2002 2001 2000
---- ---- ----
WEIGHTED-AVERAGE ASSUMPTIONS
AS OF DECEMBER 31
Discount rate 7.0% 7.5% 7.5%
Expected return on plan assets 9.0% 9.0% 9.0%
Rate of compensation increase 5.0% 5.0% 5.0%
The Corporation has a defined contribution retirement plan under
Code Section 401(k) of the Internal Revenue Service covering
employees who have completed 6 months of service and who are at
least 18 years of age. Under the plan, a participant may
contribute an amount up to 15% of their covered compensation for
the year, subject to certain limitations. The Corporation may
also make, but is not required to make, a discretionary matching
contribution. The amount of this matching contribution, if any,
is determined on an annual basis by the Board of Directors. The
Corporation made contributions to the plan for the years ended
December 31, 2002, 2001 and 2000 of $101,265, $74,880 and
$72,922, respectively.
NOTE 9. COMMITMENTS AND CONTINGENT LIABILITIES
The Fauquier Bank has entered into three long-term banking
facility leases. The first lease was entered into on January 31,
1999. The lease provides for an original five-year term with a
renewal option for additional periods of five years on the Bank's
Sudley Road, Manassas branch. Annual rent currently is $47,157.
The second lease for a branch office in Old Town Manassas was
entered into on April 10, 2001. The lease provides for an
original ten-year term with the right to renew for two additional
ten-year periods beginning on June 1, 2001. Annual rent is
$37,400 for the first five years and $40,700 annually commencing
with the sixth year.
The third lease is for the accounting and finance department
facility and was entered into on June 25, 2002. The lease has a
term of five years beginning on August 1, 2002. Rent for the
first year is $29,891 with annual increases on the anniversary
date based on the CPI with a minimum increase of 3%.
Total rent expense was $105,072, $73,076 and $48,784 for 2002,
2001 and 2000, respectively, and was included in occupancy
expense.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a schedule by year of future minimum lease
requirements required under the long-term noncancellable lease
agreements:
2003 $114,830
2004 72,521
2005 69,517
2006 72,405
2007 60,330
Thereafter 139,059
--------
Total $528,662
========
As members of the Federal Reserve System, the Corporation's
subsidiary bank is required to maintain certain average reserve
balances. For the final weekly reporting period in the years
ended December 31, 2002 and 2001, the aggregate amounts of daily
average required balances were approximately $12,146,000 and
$8,300,000, respectively.
In the normal course of business, there are outstanding various
commitments and contingent liabilities, such as guarantees,
commitments to extend credit, etc., which are not reflected in
the accompanying financial statements. The Corporation does not
anticipate losses as a result of these transactions.
See Note 15 with respect to financial instruments with
off-balance-sheet risk.
NOTE 10. INCOME TAXES
The components of the net deferred tax assets included in other
assets are as follows:
2002 2001 2000
---------- ---------- ----------
Deferred tax assets:
Allowance for loan losses $ 855,440 $ 837,466 $ 734,545
Accrued pension obligation 38,090 105,826 190,114
Interest on nonaccrual loans 59,282 31,076 1,193
Accrued vacation 58,582 -- --
Securities available for sale -- -- 44,067
Other 20,101 11,329 --
---------- ---------- ----------
1,031,495 985,697 969,919
---------- ---------- ----------
Deferred tax liabilities:
Securities available for Sale 345,219 117,011 --
Other 463 35,518 1,711
Accumulated depreciation 175,402 217,778 268,820
---------- ---------- ----------
521,084 370,307 270,531
---------- ---------- ----------
Net deferred tax assets $ 510,411 $ 615,390 $ 699,388
========== ========== ==========
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allocation of federal income taxes between current and deferred
portions is as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2002 2001 2000
----------- ----------- -----------
Current tax expense $ 1,864,972 $ 1,673,861 $ 1,586,492
Deferred tax (benefit) (123,229) (77,080) (156,891)
----------- ----------- -----------
$ 1,741,743 $ 1,596,781 $ 1,429,601
=========== =========== ===========
The reasons for the difference between the statutory federal
income tax rate and the effective tax rates are summarized as
follows:
2002 2001 2000
----------- ----------- -----------
Computed "expected" tax expense $ 1,928,330 $ 1,738,153 $ 1,538,918
Decrease in income taxes
resulting from:
Tax-exempt interest income (141,582) (135,625) (106,799)
Other (45,005) (5,747) (2,518)
----------- ----------- -----------
$ 1,741,743 $ 1,596,781 $ 1,429,601
=========== =========== ===========
NOTE 11. EARNINGS PER SHARE
The following shows the weighted average number of shares used in
computing earnings per share and the effect on weighted average
number of shares of diluted potential common stock. Potential
dilutive common stock had no effect on income available to common
shareholders. Weighted average number of shares for all periods
reported has been restated to give effect to the 100% stock
dividend in May 2002.
2002 2001 2000
--------------------- --------------------- ---------------------
PER SHARE PER SHARE PER SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- --------- --------- --------- ----------
Basic earnings per share 3,312,084 $ 1.18 3,406,866 $ 1.03 3,510,364 $ 0.88
======== ======== ========
Effect of dilutive securities,
stock options 148,044 66,830 23,182
--------- --------- ---------
Diluted earnings per share 3,460,128 $ 1.14 3,473,696 $ 1.01 3,533,546 $ 0.88
========= ======== ========= ======== ========= ========
Options 98,560 shares of common stock were not included in
computing diluted EPS in 2000, because their effects were
antidilutive.
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. STOCK OPTION PLANS
OMNIBUS STOCK OWNERSHIP AND LONG-TERM INCENTIVE PLAN
In 1998, the Corporation adopted an incentive stock option plan
under which options may be granted to certain key employees for
purchase of the Corporation's stock. The effective date of the
plan was April 21, 1998 with a ten-year term. The plan reserves
for issuance 400,000 shares of the Corporation's common stock.
The stock option plan requires that options be granted at an
exercise price equal to at least 100% of the fair market value of
the common stock on the date of the grant; however, for those
individuals who own more than 10% of the stock of the
Corporation, the option price must be at least 110% of the fair
market value on the date of grant. Such options are generally not
exercisable until three years from the date of issuance and
generally require continuous employment during the period prior
to exercise. The options will expire in no more than ten years
after the date of grant. The plan was amended and restated
effective January 1, 2000, to include non-employee directors and
added an additional 180,000 shares to be available to directors.
The plan provides for an annual issuance of 3,734 options to
non-employee directors during their initial three-year term to
achieve a total share holding of 11,200. The annual issuance of
options to nonemployee directors subsequent to their initial
three-year term requires Board action each year with a
recommended level of 2,000 options per nonemployee director per
year. The options granted under the Plan are not exercisable for
six months from the date of grant except in the case of death or
disability. Options that are not exercisable at the time a
director's services on the Board terminates for reason other than
death, disability or retirement in accordance with the
Corporation's policy will be forfeited.
DIRECTOR COMPENSATION PLANS
The Corporation maintains Nonemployee Director Stock Option
Plans. Under the plan expiring in 1999, each director that was
not an employee of the Corporation or its subsidiary received an
option grant covering 2,240 shares of Corporation common stock on
April 1 of each year during the five-year term of the plan. The
first grant under the plan was made on May 1, 1995. The exercise
price of awards was fixed at the fair market value of the shares
on the date the option is granted. During the term of the plan, a
total of 120,960 options for shares of common stock were granted.
Effective January 1, 2000, the Omnibus Stock Ownership and
Long-Term Incentive Plan for employees was amended and restated
to include non-employee directors.
The fair value of each grant is estimated at the grant date using
the Black-Scholes Option-Pricing Model with the following
weighted average assumptions:
December 31,
---------------------------------
2002 2001 2000
-------- -------- --------
Dividend yield 2.84% 2.76% 2.60%
Expected life 10 years 10 years 10 years
Expected volatility 30.82% 18.32% 18.38%
Risk-free interest rate 5.54% 5.11% 6.70%
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the status of the Omnibus Stock Ownership and
Long-Term Incentive is presented below:
2002 2001 2000
--------------------- -------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- --------- --------- --------- ---------
Outstanding at January 1 342,224 $ 8.22 259,632 $ 9.23 179,936 $ 9.97
Granted 52,130 12.85 84,592 8.07 79,696 8.13
Exercised (26,798) 9.23 (2,000) 4.38 -- --
-------- -------- --------
Outstanding at December 31 367,556 $ 8.78 342,224 $ 8.22 259,632 $ 9.23
======== ======== ========
Exercisable at end of year 233,778 190,562 140,694
Weighted-average fair value
per option of options granted
during the year $ 6.28 $ 3.11 $ 3.67
The status of the options outstanding as of December 31, 2002 for
the Omnibus Stock Ownership and Long-Term Incentive and Director
Compensation Plans is as follows:
CONTRACTUAL NUMBER EXERCISE NUMBER EXERCISE
LIFE OUTSTANDING PRICE EXERCISABLE PRICE
----------- ----------- --------- ----------- ---------
2.33 years 13,440 $ 4.38 13,440 $ 4.38
3.25 years 22,400 5.06 22,400 5.06
4.25 years 22,400 6.25 22,400 6.25
5.25 years 22,400 10.00 22,400 10.00
5.66 years 14,132 10.50 14,132 10.50
6.25 years 24,640 9.75 24,640 9.75
6.66 years 31,726 9.50 31,726 9.50
7.6 years 79,696 8.13 28,694 8.13
8.88 years 84,592 8.07 28,214 8.07
9.08 years 26,398 12.70 -- --
9.08 years 25,732 13.00 25,732 13.00
------- --------
367,556 $ 8.78 233, 778 $ 8.65
======= ========
The Corporation also maintains a Director Deferred Compensation
Plan (the "Deferred Compensation Plan"). This plan provides that
any non-employee director of the Corporation or the Bank may
elect to defer receipt of all or any portion of his or her
compensation as a director. A participating director may elect to
have amounts deferred under the Deferred Compensation Plan held
in a deferred cash account, which is credited on a quarterly
basis with interest equal to the highest rate offered by the Bank
at the end of the preceding quarter. Alternatively, a participant
may elect to have a deferred stock account in which deferred
amounts are treated as if invested in the Corporation's common
stock at the fair market value on the date of deferral. The value
of a stock account will increase and decrease based upon the fair
market value of an equivalent number of shares of common stock.
In addition, the deferred amounts deemed invested in common stock
will be credited with dividends on an equivalent number of
shares. Amounts considered invested in the Corporation's common
stock are paid, at the election of the director, either in cash
or in whole shares of the common stock and cash in lieu of
fractional shares. Directors may elect to receive amounts
contributed to their respective accounts in one or up to five
installments.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. FEDERAL HOME LOAN BANK ADVANCES
The Corporation's fixed-rate debt of $15,000,000 at December 31,
2002 matures through 2008. At December 31, 2002 and 2001, the
interest rates ranged from 4.51 percent to 4.89 percent. At
December 31, 2002 and 2001, the weighted average interest rate
was 4.64 percent.
Advances on the line are secured by all of the Corporation's
first lien loans on one-to-four unit single-family dwellings. As
of December 31, 2002, the book value of these loans totaled
approximately $70,584,000. The amount of the available credit is
limited to seventy-five percent of qualifying collateral. Any
borrowings in excess of the qualifying collateral requires
pledging of additional assets.
The contractual maturities of Federal Home Loan Bank advances are
as follows:
DECEMBER 31,
----------------------------
2002 2001
----------- -----------
Due in 2006 $10,000,000 $10,000,000
Due in 2008 5,000,000 5,000,000
----------- -----------
$15,000,000 $15,000,000
=========== ===========
An advance, dated October 1, 1998 with an outstanding balance of
$5,000,000, has an imbedded call option that gives the Federal
Home Loan Bank the option to call only on the five-year
anniversary date. The remaining advance, dated May 10, 2001 with
an outstanding balance of $10,000,000, has an imbedded call
option that gives the Federal Home Loan Bank the option to call
only on the two-year anniversary date.
NOTE 14. DIVIDEND LIMITATIONS ON AFFILIATE BANK
Transfers of funds from the banking subsidiary to the parent
corporation in the form of loans, advances and cash dividends are
restricted by federal and state regulatory authorities. As of
December 31, 2002, the aggregate amount of unrestricted funds,
which could be transferred from the banking subsidiary to the
parent corporation, without prior regulatory approval, totaled
$3,876,029.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Corporation, through its banking subsidiary, is party to
credit-related financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to
extend credit and standby letters of credit. Such commitments
involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the consolidated
balance sheets.
The Corporation's exposure to credit loss is represented by the
contractual amount of these commitments. The Corporation follows
the same credit policies in making commitments as it does for
on-balance-sheet instruments.
At December 31, 2002 and 2001, the following financial
instruments were outstanding whose contract amounts represent
credit risk:
2002 2001
----------- -----------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $42,101,041 $47,553,841
Standby letters of credit $ 4,949,261 $ 6,102,463
Commitments to extend credit are agreements to lend to a customer
as long as there is no violation of any condition established in
the contract. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee.
Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Corporation evaluates
each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the
Corporation, is based on management's credit evaluation of the
customer.
Unfunded commitments under commercial lines of credit, revolving
credit lines and overdraft protection agreements are commitments
for possible future extensions of credit to existing customers.
These lines of credit are uncollateralized and usually do not
contain a specified maturity date and may not be drawn upon to
the total extent to which the Corporation is committed.
Standby letters of credit are conditional commitments issued by
the Corporation to guarantee the performance of a customer to a
third party. Those letters of credit are primarily issued to
support public and private borrowing arrangements. The credit
risk involved in issuing letters of credit is essentially the
same as that involved in extending loan facilities to customers.
The Corporation generally holds collateral supporting those
commitments if deemed necessary.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16. FAIR VALUE OF FINANCIAL INSTRUMENTS AND INTEREST RATE RISK
The following methods and assumptions were used to estimate the
fair value of each class of financial instruments for which it is
practicable to estimate that value:
CASH, SHORT-TERM INVESTMENTS AND FEDERAL FUNDS SOLD
For those short-term instruments, the carrying amount is a
reasonable estimate of fair value.
SECURITIES
For securities and marketable equity securities held for
investment purposes, fair values are based on quoted market
prices or dealer quotes. For other securities held as
investments, fair value equals quoted market price, if
available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar
securities.
LOAN RECEIVABLES
For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on
carrying values. Fair values for certain mortgage loans
(e.g., one-to-four family residential), credit card loans,
and other consumer loans are based on quoted market prices
of similar loans sold in conjunction with securitization
transactions, adjusted for differences in loan
characteristics. Fair values for other loans (e.g.,
commercial real estate and investment property mortgage
loans, commercial and industrial loans) are estimated using
discounted cash flow analyses, using interest rates
currently being offered for loans with similar terms to
borrowers of similar credit quality. Fair values for
nonperforming loans are estimated using discounted cash flow
analyses or underlying collateral values, where applicable.
ACCRUED INTEREST
The carrying amounts of accrued interest approximate fair
value.
DEPOSIT LIABILITIES
The fair values disclosed for demand deposits (e.g.,
interest and noninterest checking, statement savings, and
certain types of money market accounts) are, by definition,
equal to the amount payable on demand at the reporting date
(i.e., their carrying amounts). The carrying amounts of
variable-rate, fixed-term money market accounts and
certificates of deposit approximate their fair values at the
reporting date. Fair values for fixed-rate certificates of
deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.
FEDERAL HOME LOAN BANK ADVANCES
The fair values of the Corporation's Federal Home Loan Bank
advances are estimated using discounted cash flow analyses
based on the Corporation's current incremental borrowing
rates for similar types of borrowing arrangements.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS
The fair value of commitments to extend credit is estimated
using the fees currently charged to enter similar
agreements, taking into account the remaining terms of the
agreements and the present credit worthiness of the
counterparties. For fixed-rate loan commitments, fair value
also considers the difference between current levels of
interest rates and the committed rates.
The fair value of standby letters of credit is based on fees
currently charged for similar agreements or on the estimated
cost to terminate them or otherwise settle the obligations
with the counterparties at the reporting date.
At December 31, 2002 and 2001, the carrying amounts of loan
commitments and standby letters of credit approximated fair
values.
The estimated fair values of the Corporation's financial
instruments are as follows:
2002 2001
-------------------- ---------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(Thousands) (Thousands)
Financial assets:
Cash and short-term investments $ 20,037 $ 20,037 $ 14,761 $ 14,761
Federal funds sold 4,900 4,900 15,421 15,421
Securities 71,737 71,737 36,908 36,908
Loans, net 213,698 215,396 207,453 213,688
Accrued interest receivable 1,740 1,740 1,590 1,590
Financial liabilities:
Deposits $273,668 $273,631 $243,747 $245,174
FHLB advances 15,000 16,354 15,000 15,060
Company-obligated mandatorily
redeemable capital securities 4,000 4,006 -- --
Accrued interest payable 417 417 558 558
The Corporation assumes interest rate risk (the risk that
general interest rate levels will change) as a result of its
normal operations. As a result, the fair values of the
Corporation's financial instruments will change when
interest rate levels change and that change may be either
favorable or unfavorable to the Corporation. Management
attempts to match maturities of assets and liabilities to
the extent believed necessary to minimize interest rate
risk. However, borrowers with fixed rate obligations are
less likely to prepay in a rising rate environment.
Conversely, depositors who are receiving fixed rates are
more likely to withdraw funds before maturity in a rising
rate environment and less likely to do so in a falling rate
environment. Management monitors rates and maturities of
assets and liabilities and attempts to minimize interest
rate risk by adjusting terms of new loans and deposits and
by investing in securities with terms that mitigate the
Corporation's overall interest rate risk.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17. OTHER OPERATING EXPENSES
The principal components of "Other operating expenses" in the
Consolidated Statements of Income are:
2002 2001 2000
---------- ---------- ----------
Advertising and business development $ 415,165 $ 398,694 $ 381,204
Bank card 464,477 426,738 408,342
Data processing 858,614 719,820 644,911
Postage and supplies 387,825 385,291 253,206
Professional and consulting fees 616,826 700,086 855,637
Prepayment penalty on FHLB advance -- 572,600 --
Other (no items exceed 1% of total revenue) 1,888,872 1,429,901 1,711,538
---------- ---------- ----------
$4,631,779 $4,633,130 $4,254,838
========== ========== ==========
NOTE 18. CONCENTRATION RISK
The Corporation maintains its cash accounts in several
correspondent banks. The total amount by which cash on deposit in
those banks exceeds the federally insured limits is approximately
$668,605 at December 31, 2002.
NOTE 19. CAPITAL REQUIREMENTS
The Corporation (on a consolidated basis) and the Bank are
subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the
Corporation's and the Bank's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt
corrective action, the Corporation and the Bank must meet
specific capital guidelines that involve quantitative measures of
their assets, liabilities, and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital
amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings,
and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital
adequacy require the Corporation and the Bank to maintain minimum
amounts and ratios (set forth in the table below) of total and
Tier 1 capital (as defined in the regulations) to risk-weighted
assets (as defined), and of Tier 1 capital (as defined) to
average assets (as defined). Management believes, as of December
31, 2002 and 2001, that the Corporation and the Bank met all
capital adequacy requirements to which they are subject.
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2002, the most recent notification from the
Federal Reserve Bank categorized the Bank as well capitalized
under the regulatory framework for prompt corrective action. To
be categorized as well capitalized, an institution must maintain
minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. There are no conditions or
events since that notification that management believes have
changed the institution's category.
The Corporation's and Subsidiary's actual capital amounts and
ratios are also presented in the table. No amount was deducted
from capital for interest-rate risk.
MINIMUM
TO BE WELL
CAPITALIZED UNDER
MINIMUM CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
---------------------- ---------------------- --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ------- --------- ------- -------- -------
As of December 31, 2002: (Amount in Thousands)
Total Capital (to Risk
Weighted Assets):
Consolidated $ 32,254 15.5% $ 16,639 8.0% N/A N/A
The Fauquier Bank $ 32,182 15.5% $ 16,630 8.0% $ 20,788 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 29,652 14.3% $ 8,319 4.0% N/A N/A
The Fauquier Bank $ 29,580 14.2% $ 8,315 4.0% $ 12,473 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 29,652 9.4% $ 12,684 4.0% N/A N/A
The Fauquier Bank $ 29,580 9.3% $ 12,680 4.0% $ 15,851 5.0%
As of December 31, 2001:
Total Capital (to Risk
Weighted Assets):
Consolidated $ 26,427 13.2% $ 15,953 8.0% N/A N/A
The Fauquier Bank $ 26,138 13.1% $ 15,923 8.0% $ 19,903 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $ 23,930 12.0% $ 7,977 4.0% N/A N/A
The Fauquier Bank $ 23,646 11.9% $ 7,961 4.0% $ 11,942 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $ 23,930 8.3% $ 11,533 4.0% N/A N/A
The Fauquier Bank $ 23,646 8.2% $ 11,538 4.0% $ 14,422 5.0%
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20. COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES
On March 11, 2002, Fauquier Statutory Trust I, a wholly-owned
subsidiary of the Corporation, was formed for the purpose of
issuing redeemable Capital Securities. On March 26, 2002, $4
million of trust preferred securities were issued through a
pooled underwriting totaling approximately $564 million. The
securities have a LIBOR-indexed floating rate of interest. During
2002, the interest rates ranged from 5.00% to 5.59%. At December
31, 2002 the weighted-average interest rate was 5.48%. The
securities have a mandatory redemption date of March 26, 2032,
and are subject to varying call provisions beginning March 27,
2007. The principal asset of the Trust is $4.1 million of the
Corporation's junior subordinated debt securities with the like
maturities and like interest rates to the Capital Securities.
The Trust Preferred Securities may be included in Tier 1 capital
for regulatory capital adequacy determination purposes up to 25%
of Tier 1 capital after its inclusion. The portion of the Trust
Preferred not considered as Tier 1 capital may be included in
Tier 2 capital.
The obligations of the Corporation with respect to the issuance
of the Capital Securities constitute a full and unconditional
guarantee by the Corporation of the Trust's obligations with
respect to the Capital Securities.
Subject to certain exception and limitations, the Corporation may
elect from time to time to defer interest payments on the junior
subordinated debt securities, which would result in a deferral of
distribution payments on the related Capital Securities.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21. PARENT CORPORATION ONLY FINANCIAL STATEMENTS
FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
BALANCE SHEETS
December 31, 2002 and 2001
DECEMBER 31,
--------------------------
ASSETS 2002 2001
----------- -----------
Cash on deposit with subsidiary bank $ 246,995 $ 76,164
Investment in subsidiaries, at cost,
plus equity in undistributed net income 30,369,777 23,872,648
Dividend receivable 363,447 318,356
Other assets 122,947 377,769
----------- -----------
$31,103,166 $24,644,937
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Company-obligated mandatorily redeemable capital securities 4,120,000 $ --
Dividend payable 363,447 318,356
Other liabilities 188,554 169,182
----------- -----------
4,672,001 487,538
----------- -----------
SHAREHOLDERS' EQUITY
Common stock 10,341,726 5,244,500
Retained earnings, which are substantially
undistributed earnings of subsidiaries 15,419,307 18,685,761
Accumulated other comprehensive income 670,132 227,138
----------- -----------
26,431,165 24,157,399
----------- -----------
Total liabilities and shareholders' equity $31,103,166 $24,644,937
=========== ===========
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
STATEMENTS OF INCOME
For Each of the Three Years in the Period Ended December 31, 2002
2002 2001 2000
----------- ----------- -----------
REVENUE, dividends from subsidiaries $ 2,277,687 $ 2,530,732 $ 2,237,339
----------- ----------- -----------
EXPENSES
Interest expense 170,379 -- --
Legal and professional fees 101,073 28,624 35,613
Directors' fees 53,010 52,432 6,632
Miscellaneous 76,889 35,963 15,003
----------- ----------- -----------
Total expenses 401,351 117,019 57,248
----------- ----------- -----------
Income before income tax benefit
and equity in undistributed net
income of subsidiaries 1,876,336 2,413,713 2,180,091
Income tax (benefit) (136,459) (39,786) (19,464)
----------- ----------- -----------
Income before equity in
undistributed net income
of subsidiaries 2,012,795 2,453,499 2,199,555
Equity in undistributed net income
of subsidiaries 1,917,021 1,061,935 897,073
----------- ----------- -----------
Net income $ 3,929,816 $ 3,515,434 $ 3,096,628
=========== =========== ===========
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
STATEMENTS OF CASH FLOWS
For Each of the Three Years in the Period Ended December 31,
2002
2002 2001 2000
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,929,816 $ 3,515,434 $ 3,096,628
Adjustments to reconcile net income to net cash
provided by operating activities:
Undistributed earnings of subsidiaries (1,917,021) (1,061,935) (897,074)
(Increase) in undistributed dividends
receivable from subsidiaries (45,091) (27,284) (25,302)
Tax benefit of nonqualified options exercised (17,114) -- --
(Increase) decrease in other assets 254,822 (377,769) --
Increase (decrease) in other liabilities 19,372 43,465 (25,910)
----------- ----------- -----------
Net cash provided by operating activities 2,224,784 2,091,911 2,148,342
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of capital securities 4,120,000 -- --
Contribution of capital to subsidiaries (4,120,000) -- --
Cash dividends paid (1,310,949) (1,194,739) (1,092,198)
Issuance of common stock 307,520 28,309 22,932
Acquisition of common stock (1,050,524) (895,941) (1,069,839)
----------- ----------- -----------
Net cash (used in) financing activities (2,053,953) (2,062,371) (2,139,105)
----------- ----------- -----------
Increase in cash and cash equivalents 170,831 29,540 9,237
CASH AND CASH EQUIVALENTS
Beginning 76,164 46,624 37,387
----------- ----------- -----------
Ending 246,995 76,164 46,624
=========== =========== ===========
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
67
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning Bankshares' executive officers is provided in Part I of
this Form 10-K under the caption "Executive Officers of the Registrant." All
other information concerning Bankshares required by this item is contained in
Bankshares' definitive proxy statement for the 2003 annual meeting of
shareholders, to be filed within 120 days of the fiscal year ended December 31,
2002 (the "2003 proxy statement") under the captions "Election of Class I
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance," and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to director and executive compensation is contained in
Bankshares' 2003 proxy statement under the caption "Remuneration and Other
Transactions with Management," and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information regarding security ownership required by this item is contained
in Bankshares' 2003 proxy statement under the caption "Security Ownership of
Certain Beneficial Owners and Management," and is incorporated herein by
reference.
The following table sets forth information as of December 31, 2002 with respect
to compensation plans under which equity securities of Bankshares are authorized
for issuance:
EQUITY COMPENSATION PLAN INFORMATION
- ----------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE EQUITY COMPENSATION PLANS
BE ISSUED UPON EXERCISE EXERCISE PRICE OF (EXCLUDING SECURITIES
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, REFLECTED IN COLUMN (A))
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS (C)
(A) (B)
- ----------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security
holders 262,276 $9.04 295,646 (1)
- ----------------------------------------------------------------------------------------------------------------
Equity compensation plans
not approved by security
holders 118,208 $7.48 87,072 (2)
- ----------------------------------------------------------------------------------------------------------------
TOTAL 380,484 $8.56 382,718
- ----------------------------------------------------------------------------------------------------------------
(1) Includes 295,646 shares available to be granted in the form of options,
restricted stock or stock appreciation rights under the Omnibus Stock Ownership
and Long Term Incentive Plan.
(2) Includes no shares available to be granted under the Non-Employee Director
Stock Option Plan and 87,072 shares available to be granted under the Director
Deferred Compensation Plan.
For additional information concerning the material features of Bankshares'
equity compensation plans, including the Non-Employee Director Stock Option
Plan and Director Deferred Compensation Plan which have not been approved by the
shareholders, please see Note 12 of our Notes to Consolidated Financial
Statements.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is contained in Bankshares' 2003 proxy
statement under the caption "Related Party Transactions," and is incorporated
herein by reference.
68
ITEM 14. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
- ------------------------------------------------
As a result of the enactment of the Sarbanes-Oxley Act of 2002, issuers such as
Bankshares that file periodic reports under the Exchange Act of 1934 are now
required to include in those reports certain information concerning the issuer's
controls and procedures for complying with the disclosure requirements of the
federal securities laws. These disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by an issuer in the reports it files or submits under
the Act, is communicated to the issuer's management, including its principal
executive officer or officers and principal financial officer or officers, or
persons performing similar functions, as appropriate to allow timely decisions
regarding required disclosure.
We have established disclosure controls and procedures to ensure that material
information related to Bankshares is made known to our principal executive
officer and principal financial officer on a regular basis, in particular during
the periods in which our quarterly and annual reports are being prepared. These
disclosure controls and procedures consist principally of communications between
and among the chief executive officer and the chief financial officer, and the
other executive officers of Bankshares and its subsidiaries to identify any new
transactions, events, trends, contingencies or other matters that may be
material to Bankshares' operations. As required, we evaluate the effectiveness
of these disclosure controls and procedures on a quarterly basis, and most
recently did so as of a date within 90 days prior to the filing of this
quarterly report. Based on this evaluation, Bankshares' management, including
the chief executive officer and the chief financial officer, concluded that such
disclosure controls and procedures were operating effectively as designed as of
the date of such evaluation.
Changes in Internal Controls
- ----------------------------
There were no significant changes in Bankshares' internal controls pertaining to
its financial reporting and control of its assets or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
69
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) - Financial Statements
The following consolidated financial statements of Fauquier Bankshares, Inc. and
subsidiaries are filed as part of this document under Item 8. Financial
Statements and Supplementary Data.
Independent Auditor's Report on the Consolidated Financial Statements
Consolidated Balance Sheets - December 31, 2002 and December 31, 2001
Consolidated Statements of Income - Years ended December 31, 2002, 2001
and 2000
Consolidated Statements of Cash Flows - Years ended December 31, 2002,
2001 and 2000
Consolidated Statements of Changes in Shareholders' Equity - December 31,
2002, 2001 and 2000
Notes to Consolidated Financial Statements - Years ended December 31,
2002, 2001 and 2000
(a) (2) - Financial Statement Schedules
All schedules to the consolidated financial statements required by Article 9 of
Regulation S-X are omitted since they are either not applicable or the required
information is set forth in the consolidated financial statements or notes
thereto.
(a) (3) - Exhibits
EXHIBIT NUMBER
--------------
3.1 Articles of Incorporation of Fauquier Bankshares, Inc., as
amended, incorporated by reference to Exhibit 3(i) to
registration statement on Form 10 filed April 16, 1999
3.2 Bylaws of Fauquier Bankshares, Inc., incorporated by reference
to Exhibit 3(ii) to registration statement on Form 10 filed
April 16, 1999
Certain instruments relating to capital securities not being registered have
been omitted in accordance with Item 601(b)(4)(iii) of Regulation S-K. The
registrant will furnish a copy of any such instrument to the Securities and
Exchange Commission upon its request.
10.1 Fauquier Bankshares, Inc. Omnibus Stock Ownership and Long
Term Incentive Plan, amended and restated effective January 1,
2000, incorporated by reference to Exhibit 4.B to Form S-8
filed October 15, 2002
10.2 Fauquier Bankshares, Inc. Director Deferred Compensation Plan,
as adopted effective May 1, 1995, incorporated by reference to
Exhibit 4.C to Form S-8 filed October 15, 2002
10.3 Fauquier Bankshares, Inc. Non-Employee Director Stock Option
Plan, effective April 1, 1995, incorporated by reference to
Exhibit 4.A to Form S-8 filed October 15, 2002
10.4 Change of Control Agreement, dated November 16, 1994, and
amended June 13, 1997, between Fauquier Bankshares, Inc. and
C. Hunton Tiffany
10.5 Change of Control Agreement, dated November 16, 1994 and
amended June 13, 1997, between Fauquier Bankshares, Inc. and
Randy K. Ferrell
10.6 Change of Control Agreement, dated February 28, 1994 and
amended June 13, 1997, between Fauquier Bankshares, Inc. and
Gary R. Shook
10.7 Change of Control Agreement, dated and amended December 18,
2000, between Fauquier Bankshares, Inc. and Rosanne T.
Gorkowski
10.8 Change of Control Agreement, dated and amended November 27,
2000, between Fauquier Bankshares, Inc. and Eric P. Graap
10.9 Change of Control Agreement, dated and amended February 22,
2002, between Fauquier Bankshares, Inc. and Mark A. Debes
10.10 Executive Supplemental Retirement Plan Agreement, dated August
20, 2000, between Fauquier Bankshares, Inc. and C. Hunton
Tiffany
10.11 Life Insurance Endorsement Method Split Dollar Plan Agreement,
dated August 10, 2000, between Fauquier Bankshares, Inc. and
C. Hunton Tiffany
10.12 Executive Split Dollar Life Insurance Agreement,
dated November 26, 1996, between Fauquier Bankshares, Inc. and
Randy K. Ferrell
70
21 Subsidiaries of the Registrant, incorporated herein by
reference to Part I of this Form 10-K
(b) Reports on Form 8-K Filed in the fourth quarter of 2002:
None.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FAUQUIER BANKSHARES, INC.
/s/ C. Hunton Tiffany
- ------------------------------------------------
C. Hunton Tiffany
President and Chief Executive Officer
Dated: March 20, 2003
/s/ Eric P. Graap
- -------------------------------------------
Eric P. Graap
Senior Vice President and Chief Financial Officer
Dated: March 20, 2003
(Certifications of CEO and CFO under Section 906 of the Sarbanes-Oxley Act
of 2002 are enclosed separately as correspondence with this filing.)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ C. Hunton Tiffany Chief Executive Officer, March 20, 2003
- ------------------------------- Director
C. Hunton Tiffany
/s/ Alexander G. Green, Jr. Director March 20, 2003
- -------------------------------
Alexander G. Green, Jr.
/s/ Stanley C. Haworth Director March 20, 2003
- -------------------------------
Stanley C. Haworth
/s/ John J. Norman, Jr Director March 20, 2003
- -------------------------------
John J. Norman, Jr.
/s/ Douglas C. Larson Director March 20, 2003
- -------------------------------
Douglas C. Larson
/s/ C.H. Lawrence, Jr. Director March 20, 2003
- -------------------------------
C.H. Lawrence, Jr.
/s/ D. Harcourt Lees, Jr. Director March 20, 2003
- -------------------------------
D. Harcourt Lees, Jr.
/s/ Randolph T. Minter Director March 20, 2003
- -------------------------------
Randolph T. Minter
/s/ B.S. Montgomery Director March 20, 2003
- -------------------------------
B.S. Montgomery
/s/ H.P. Neale Director March 20 2003
- -------------------------------
H.P. Neale
72
/s/ Pat H. Nevill Director March 20, 2003
- -------------------------------
Pat H. Nevill
/s/ Henry M. Ross Director March 20, 2003
- -------------------------------
Henry M. Ross
/s/ H. Frances Stringfellow Director March 20, 2003
- -------------------------------
H. Frances Stringfellow
73
CERTIFICATIONS
I, C. Hunton Tiffany, certify that:
1. I have reviewed this annual report on Form 10-K of Fauquier
Bankshares, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
C. Hunton Tiffany
Dated: March 21, 2003 /s/ C. Hunton Tiffany
-------------------------------------
C. Hunton Tiffany
President and Chief Executive Officer
74
I, Eric P. Graap, certify that:
1. I have reviewed this annual report on Form 10-K of Fauquier
Bankshares, Inc.;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Dated: March 21, 2003 /s/ Eric P. Graap
-------------------------------
Eric P. Graap
Senior Vice President and
Chief Financial Officer
75