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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
--------------
FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission File No. 2-25805
FAUQUIER BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA 54-1288193
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
10 COURTHOUSE SQUARE
WARRENTON, VIRGINIA 20186
(Address of principal executive offices) (Zip Code)
(540) 347-2700
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes No X
--- ---
As of August 9, 2003, the latest practicable date for determination,
3,317,620 shares of common stock, par value $3.13 per share, of the registrant
were outstanding.
FAUQUIER BANKSHARES, INC.
INDEX
Part I. FINANCIAL INFORMATION
Page
Item 1. Financial Statements 1
Consolidated Balance Sheets as of June 30, 2003
(unaudited) and December 31, 2002 1
Consolidated Statements of Income (unaudited) for
the Three Months Ended June 30, 2003 and 2002 2
Consolidated Statements of Income (unaudited) for
the Six Months Ended June 30, 2003 and 2002 3
Consolidated Statements of Changes in Shareholders'
Equity (unaudited) for the Six Months Ended
June 30, 2003 and 2002 4
Consolidated Statements of Cash Flows (unaudited)
for the Six Months Ended June 30, 2003 and 2002 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 20
Item 4. Controls and Procedures 21
Part II. OTHER INFORMATION 21
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, 2003 DECEMBER 31, 2002
------------- -----------------
ASSETS
Cash and due from banks $ 15,308,466 $ 19,824,120
Interest-bearing deposits in other banks 386,233 212,960
Federal funds sold 21,059,000 4,900,000
Securities, at fair value 65,754,176 71,736,633
Loans, net of allowance for loan losses of $3,120,527
in 2003 and $2,909,607 in 2002 247,959,307 213,697,948
Bank premises and equipment, net 7,844,050 6,468,205
Accrued interest receivable 1,967,700 1,739,638
Other assets 8,188,266 2,919,978
------------ ------------
Total assets $368,467,198 $321,499,482
============ ============
LIABILITIES
Deposits:
Noninterest-bearing $ 86,356,707 $ 60,181,808
Interest-bearing 233,186,952 213,486,663
------------ ------------
Total deposits $319,543,659 $273,668,471
Federal Home Loan Bank advances 15,000,000 15,000,000
Company-obligated mandatorily redeemable capital securities 4,000,000 4,000,000
Dividends payable 397,337 363,447
Other liabilities 2,147,930 2,036,399
Commitments and contingent liabilities -- --
------------ ------------
Total liabilities $341,088,926 $295,068,317
============ ============
SHAREHOLDERS' EQUITY
Common stock, par value, $3.13; authorized 8,000,000 shares;
issued and outstanding, 2003, 3,311,144 shares; 2002, 3,304,066 shares 10,363,881 10,341,726
Retained earnings 16,651,977 15,419,307
Accumulated other comprehensive income 362,414 670,132
------------ ------------
Total shareholders' equity $ 27,378,272 $ 26,431,165
------------ ------------
Total liabilities and shareholders' equity $368,467,198 $321,499,482
============ ============
See accompanying Notes to Consolidated Financial Statements.
1
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND 2002
2003 2002
---------- ----------
INTEREST INCOME
Interest and fees on loans $4,126,471 $4,345,051
Interest and dividends on securities available for sale:
Taxable interest income 378,356 488,559
Interest income exempt from federal income taxes 18,375 28,180
Dividends 61,894 34,181
Interest on federal funds sold 33,599 57,797
Interest on deposits in other banks 267 340
---------- ----------
Total interest income 4,618,962 4,954,108
---------- ----------
INTEREST EXPENSE
Interest on deposits 805,018 1,126,095
Interest on Federal Home Loan Bank advances 175,807 175,807
Distribution on capital securities of subsidiary trust 49,257 56,467
---------- ----------
Total interest expense 1,030,082 1,358,369
---------- ----------
Net interest income 3,588,880 3,595,739
Provision for loan losses 155,000 93,750
---------- ----------
Net interest income after
provision for loan losses 3,433,880 3,501,989
---------- ----------
OTHER INCOME
Wealth management income 216,020 129,348
Service charges on deposit accounts 620,381 483,357
Other service charges, commissions and fees 368,936 254,992
Other operating income 10,378 9,517
---------- ----------
Total other income 1,215,715 877,214
---------- ----------
OTHER EXPENSES
Salaries and employees' benefits 1,585,051 1,373,564
Net occupancy expense of premises 206,418 173,714
Furniture and equipment 292,577 245,412
Other operating expenses 1,216,197 1,169,974
---------- ----------
Total other expenses 3,300,243 2,962,664
---------- ----------
Income before income taxes 1,349,352 1,416,539
---------- ----------
Income tax expense 403,154 444,291
---------- ----------
Net Income $ 946,198 $ 972,248
========== ==========
EARNINGS PER SHARE, basic $ 0.28 $ 0.29
========== ==========
EARNINGS PER SHARE, assuming dilution $ 0.27 $ 0.28
========== ==========
DIVIDENDS PER SHARE $ 0.12 $ 0.10
========== ==========
See accompanying Notes to Consolidated Financial Statements.
2
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
2003 2002
---------- ----------
INTEREST INCOME
Interest and fees on loans $8,104,995 $8,571,019
Interest and dividends on securities available for sale:
Taxable interest income 908,382 858,274
Interest income exempt from federal income taxes 38,037 62,465
Dividends 121,347 63,067
Interest on federal funds sold 36,739 101,106
Interest on deposits in other banks 728 1,586
---------- ----------
Total interest income 9,210,228 9,657,517
---------- ----------
INTEREST EXPENSE
Interest on deposits 1,597,173 2,281,907
Interest on federal funds purchased 5,381 --
Interest on Federal Home Loan Bank advances 349,682 349,682
Distribution on capital securities of subsidiary trust 99,257 59,573
---------- ----------
Total interest expense 2,051,493 2,691,162
---------- ----------
Net interest income 7,158,735 6,966,355
Provision for loan losses 230,000 187,500
---------- ----------
Net interest income after
provision for loan losses 6,928,735 6,778,855
---------- ----------
OTHER INCOME
Wealth management income 434,775 331,602
Service charges on deposit accounts 1,252,439 955,051
Other service charges, commissions and fees 642,433 476,354
Other operating income 19,750 42,559
---------- ----------
Total other income 2,349,397 1,805,566
---------- ----------
OTHER EXPENSES
Salaries and employees' benefits 3,171,348 2,770,605
Net occupancy expense of premises 415,021 346,072
Furniture and equipment 584,266 490,071
Other operating expenses 2,211,141 2,250,950
---------- ----------
Total other expenses 6,381,776 5,857,698
---------- ----------
Income before income taxes 2,896,356 2,726,723
---------- ----------
Income tax expense 859,164 842,937
---------- ----------
Net Income $2,037,192 $1,883,786
========== ==========
EARNINGS PER SHARE, basic $ 0.61 $ 0.56
========== ==========
EARNINGS PER SHARE, assuming dilution $ 0.59 $ 0.54
========== ==========
DIVIDENDS PER SHARE $ 0.23 $ 0.20
========== ==========
See accompanying Notes to Consolidated Financial Statements.
3
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
ACCUMULATED OTHER
COMMON RETAINED COMPREHENSIVE COMPREHENSIVE
STOCK EARNINGS INCOME (LOSS) INCOME TOTAL
--------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 2001 $ 5,244,500 $ 18,685,761 $ 227,138 $ 24,157,399
Comprehensive income:
Net income -- 1,883,786 -- $ 1,883,786 1,883,786
Other comprehensive income net of tax:
Unrealized holding losses on securities
available for sale, net of deferred
income taxes of $183,110 -- -- 355,449 355,449 355,449
------------
Total comprehensive income -- -- -- $ 2,239,235 --
============
100% Stock Dividend 5,185,020 (5,185,020)
Cash dividends -- (662,818) -- (662,818)
Acquisition of 23,135 shares of common stock (72,413) (525,080) -- (597,493)
Issuance of common stock 5,547 37,424 42,971
Exercise of stock options 7,387 17,463 -- 24,850
---------------------------------------------- ------------
BALANCE, JUNE 30, 2002 $ 10,370,041 $ 14,251,516 $ 582,587 $ 25,204,144
BALANCE, DECEMBER 31, 2002 $ 10,341,726 $ 15,419,307 $ 670,132 $ 26,431,165
Comprehensive income:
Net income -- 2,037,192 -- $ 2,037,192 2,037,192
Other comprehensive income net of tax:
Unrealized holding losses on securities
available for sale, net of deferred
income taxes of $158,521 -- -- (307,718) (307,718) (307,718)
------------
Total comprehensive income -- -- -- $ 1,729,474 --
============
Cash dividends (760,220)
-- (760,220) --
Acquisition of 9,900 shares of common stock (30,987) (123,397) -- (154,384)
Issuance of common stock 26,480 19,850 -- 46,330
Exercise of stock options 26,662 59,245 -- 85,907
---------------------------------------------------------------------------------- ------------
BALANCE, JUNE 30, 2003 $ 10,363,881 $ 16,651,977 $ 362,414 $ 27,378,272
============================================== ============
See accompanying Notes to Consolidated Financial Statements.
4
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,037,192 $ 1,883,786
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 504,312 462,058
Provision for loan losses 230,000 187,500
(Gain) on sale of premises and equipment -- (6,651)
Net premium amortization of investment securities 452,803 155,021
Changes in assets and liabilities:
(Increase) in other assets (337,934) (235,279)
Increase (decrease) in other liabilities 111,531 (151,437)
------------ ------------
Net cash provided by operating activities 2,997,904 2,294,998
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities, calls and principal
payments of securities available for sale 23,295,390 4,309,118
Purchase of securities available for sale (18,231,870) (22,996,469)
Proceeds from sale of premises and equipment -- 6,651
Purchase of premises and equipment (1,880,157) (686,710)
Purchase of Bank-Owned Life Insurance (5,000,000) --
Net (increase) in loans (34,491,359) (7,309,934)
------------ ------------
Net cash (used in) investing activities (36,307,996) (26,677,344)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts
and savings accounts 34,292,453 16,767,173
Net increase in certificates of deposit 11,582,735 1,782,422
Proceeds from issuance of capital securities -- 4,000,000
Cash dividends paid (726,330) (649,863)
Issuance of common stock 132,237 67,821
Acquisition of common stock (154,384) (597,493)
------------ ------------
Net cash provided by financing activities 45,126,711 21,370,060
------------ ------------
Increase (decrease) in cash and cash equivalents 11,816,619 (3,012,286)
CASH AND CASH EQUIVALENTS
Beginning 24,937,080 30,182,031
------------ ------------
Ending $ 36,753,699 $ 27,169,745
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 2,071,631 $ 2,739,787
============ ============
Income taxes $ 641,000 $ 624,000
============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES
Unrealized gain (loss) on securities available for sale, net $ (466,239) $ 538,559
============ ============
See accompanying Notes to Consolidated Financial Statements.
5
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The consolidated financial statements include the accounts of Fauquier
Bankshares, Inc. (the "Company") and its subsidiary, The Fauquier Bank. All
significant intercompany balances and transactions have been eliminated. In
the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial positions as
of June 30, 2003 and December 31, 2002; the results of operations for the
three and six months ended June 30, 2003 and 2002; and the cash flows for
the six months ended June 30, 2003 and 2002.
The results of operations for the three and six months ended June 30, 2003
and 2002 are not necessarily indicative of the results expected for the
full year.
2. SECURITIES
The amortized cost of securities available for sale, with unrealized gains
and losses follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
------------ ------------ ------------ ------------
June 30, 2003
--------------------------------------------------------------------------
Obligations of U.S.
Government corporations
and agencies $ 54,105,792 $ 416,930 $ -- $ 54,522,722
Obligations of states and political
subdivisions 1,536,590 98,526 -- 1,635,116
Corporate Bonds 1,999,635 42,805 -- 2,042,440
Mutual Funds 5,123,143 -- (4,045) 5,119,098
Other 1,000,000 -- -- 1,000,000
Restricted investments:
Federal Home Loan
Bank stock 830,300 -- -- 830,300
Federal Reserve Bank
stock 72,000 -- -- 72,000
Community Bankers'
Bank stock 50,000 -- -- 50,000
FHLMC Preferred
Bank stock 487,500 -- (5,000) 482,500
------------ ------------ ------------ ------------
$ 65,204,960 $ 558,261 $ (9,045) $ 65,754,176
============ ============ ============ ============
6
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
------------ ------------ ------------ ------------
December 31, 2002
--------------------------------------------------------------------------
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
Bank stock 487,500 -- (7,500) 480,000
------------ ------------ ------------ ------------
$ 70,721,283 $ 1,026,849 $ (11,499) $ 71,736,633
============ ============ ============ ============
3. LOANS
A summary of the balances of loans follows:
JUNE 30, DECEMBER 31,
2003 2002
-------- -------------
(Thousands)
Real estate loans:
Construction $ 14,165 $ 10,685
Secured by farmland 3,243 2,416
Secured by 1-4 family residential 87,932 76,646
Other real estate loans 69,632 62,030
Commercial and industrial loans (except those secured by real estate) 25,967 20,386
Consumer installment loans 38,862 35,397
All other loans 11,375 9,186
-------- --------
Total loans $251,176 $216,746
Less: Unearned income 96 138
Allowance for loan losses 3,121 2,910
-------- --------
Net loans $247,959 $213,698
======== ========
7
Analysis of the allowance for loan losses follows:
SIX MONTHS SIX MONTHS TWELVE MONTHS
ENDING ENDING ENDING
JUNE 30, JUNE 30, DECEMBER 31,
2003 2002 2002
---------- ---------- -------------
(Thousands)
Balance at beginning of period $ 2,910 $ 2,857 $ 2,857
Provision charged to operating expense 230 188 346
Recoveries added to the allowance 101 17 48
Loan losses charged to the allowance (120) (100) (341)
------- ------- -------
Balance at end of period $ 3,121 $ 2,962 $ 2,910
======= ======= =======
Nonperforming assets consist of the following:
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
(Thousands)
Nonaccrual loans $1,004 $ 850
Restructured loans -- --
------ ------
Total non-performing loans 1,004 850
Foreclosed real estate -- --
------ ------
Total non-performing assets $1,004 $ 850
====== ======
Total loans past due 90 days or more and still accruing interest totaled
$265,000 on June 30, 2003 and $244,000 on December 31, 2002, respectively.
4. COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY
TRUST
On March 26, 2002, the Company's wholly-owned Connecticut statutory
business trust privately issued $4 million face amount of the trust's
Floating Rate Capital Securities ("Capital Securities") in a pooled capital
securities offering. Simultaneously, the trust used the proceeds of that
sale to purchase $4 million principal amount of the Company's Floating Rate
Junior Subordinated Deferrable Interest Debentures due 2032 ("Subordinated
Debentures"). Both the Capital Securities and the Subordinated Debentures
are callable at any time after five years from the issue date. The
Subordinated Debentures are an unsecured obligation of the Company and are
junior in right of payment to all present and future senior indebtedness of
the Company. The Capital Securities are guaranteed by the Company on a
subordinated basis.
The Capital Securities are presented in the consolidated balance sheets of
the Company under the caption "Company-Obligated Mandatorily Redeemable
Capital Securities." The Company records distributions payable on the
Capital Securities as an Interest Expense in its consolidated statements of
income. The cost of issuance of the Capital Securities was approximately
$128,000. This cost is being amortized over a five year period from the
issue date.
8
5. EARNINGS PER SHARE
The following table 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. Weighted average number of shares
for all periods reported have been restated to give effect to the 100%
stock dividend in May 2002.
THREE MONTHS SIX MONTHS SIX MONTHS
ENDING ENDING ENDING
JUNE 30, 2003 JUNE 30, 2003 JUNE 30, 2002
PER SHARE PER SHARE PER SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- --------- --------- --------- ---------
Basic earnings per share 3,307,058 $ 0.28 3,304,165 $ 0.61 3,338,613 $ 0.56
======== ======== ========
Effect of dilutive securities, stock options 168,622 166,178 142,880
--------- --------- ---------
Diluted earnings per share 3,475,680 $ 0.27 3,470,343 $ 0.59 3,481,493 $ 0.54
========= ======== ========= ======== ========= =========
6. STOCK-BASED COMPENSATION
The Company has a stock-based compensation plan. The Company 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 Company had the fair value recognition provisions of FASB Statement
No. 123, "Accounting for Stock-Based Compensation", been applied to stock-
based compensation.
June 30 June 30
2003 2002
----------- -----------
Net income , as reported $ 2,037,192 $ 1,883,786
Deduct: total stock-based employee compensation
expense determined based on fair value
method of awards, net of tax $ (82,802) $ (197,787)
----------- -----------
Pro forma net income $ 1,954,390 $ 1,685,999
=========== ===========
Earnings per share:
Basic - as reported $ 0.61 $ 0.56
----------- -----------
Basic - pro forma $ 0.59 $ 0.50
----------- -----------
Diluted - as reported $ 0.59 $ 0.54
----------- -----------
Diluted - pro forma $ 0.56 $ 0.48
----------- -----------
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
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-Q. In addition to the historical information contained
herein, this report contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. Forward-looking
statements, which are based on certain assumptions and describe future plans,
strategies, and expectations of management, 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, performance 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,
legislative/regulatory climate, monetary and fiscal policies of the U.S.
Government, including the policies of the U.S. Treasury and the Board of
Governors of the Federal Reserve System, the quality or composition of the 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.
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"),
a Virginia state-chartered bank that commenced operations in 1902. Bankshares
engages in its business through TFB and has no significant operations other
than owning the stock of TFB. Bankshares had issued and outstanding 3,311,144
shares of common stock, par value $3.13 per share, held by approximately 390
shareholders of record on June 30, 2003.
TFB has seven full-service branch offices located in the Virginia communities of
Warrenton, Catlett, The Plains, Manassas and New Baltimore. The executive
offices of Bankshares and the main branch office of TFB are located at 10
Courthouse Square, Warrenton, Virginia 20186. In April 2003, TFB purchased real
estate in Bealeton, Virginia, and subject to receipt of required governmental
and regulatory approvals, plans to open its eighth full-service branch office in
Bealeton during the second half of 2003.
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 Corporation
(the "FDIC"). The basic services offered by TFB include: demand interest bearing
and non-interest bearing deposit accounts, money market deposit accounts, NOW
accounts, time deposits, safe deposit services, credit and check cards, cash
management, direct deposits, notary services, 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 and telephone. 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 division that began with the granting
of trust powers to TFB in 1919. The Wealth Management Services division provides
personalized services that include investment
10
management, trust, estate settlement, retirement, insurance, and brokerage
services. TFB through its subsidiary Fauquier Bank Services, Inc., has an equity
ownership interest 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 an equity investment gain of $14,000 for Bankers Insurance during the
first half of 2003, but a loss of $32,000 for Bankers Investments Group related
to the start-up expenses for the same time period.
The revenues of TFB are primarily derived from interest on, and fees received in
connection with, real estate, commercial and consumer 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, and the sale and maturity of investment
securities, and advance borrowings from the Federal Home Loan Bank ("FHLB") of
Atlanta. The principal expenses of TFB are the interest paid on deposits and
borrowings, and operating and general administrative expenses.
TFB's general market area principally includes Fauquier and western Prince
William counties, and is located approximately fifty (50) miles southwest of
Washington, D.C.
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 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 can be estimated 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.
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 1-to-4 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
11
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.
COMPARISION OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND
JUNE 30, 2002
NET INCOME. Net income for the three months ended June 30, 2003 was $946,000 or
$0.27 per diluted share compared with $972,000 or $0.28 per diluted share for
the three months ended June 30, 2002.
NET INTEREST INCOME. Net interest income decreased $7,000 or 0.2% to $3.59
million for the three months ended June 30, 2003 compared with $3.60 million for
the three months ended June 30, 2002. The decrease resulted from reduced
interest and fee income on loans and investments resulting from declining market
interest rates, which were offset by reduced interest expense on deposits. The
net interest margin, computed on a tax equivalent basis, for the June 2003
quarter was 4.63% compared with 5.22% for the same quarter one year earlier. The
decrease in the net interest margin can be primarily attributed to the declining
interest rate environment, and the corresponding reduction in the average rate
on earning assets, which declined on a tax equivalent basis to 5.94% for the
quarter ended June 30, 2003, from 7.19% for the quarter ended June 30, 2002.
Average interest-earning assets grew 13.2% to $313.2 million for the second
quarter of 2003 compared with $276.7 million for the second quarter of 2002.
Total interest income decreased $335,000 or 6.8% to $4.62 million for the three
months ended June 30, 2003, compared to $4.95 million for the three months ended
June 30, 2002, as a result of the declining interest rate environment and its
effect on the yield on interest-earning assets. Interest and fees on loans
decreased $219,000, or 5.0% to $4.13 million for the June 2003 quarter. Average
loans outstanding totaled $238.7 million and earned 6.96% on a tax-equivalent
basis for the quarter ended June 30, 2003, compared with $215.3 million and
8.08%, respectively, for the quarter ended June 30, 2002. Investment securities
income decreased $92,000 or 16.8%, while interest on federal funds sold
decreased $24,000 or 41.9%. Investment securities and federal funds sold
averaged $62.7 million and $11.8 million, respectively, for the second quarter
of 2003 compared with $47.6 million and $13.8 million for the same quarter one
year earlier. The yield on investment securities and federal funds was 2.69% on
a tax-equivalent basis for the second quarter of 2003, compared with 4.06% for
the first quarter of 2002.
Total interest expense decreased $328,000 or 24.2% to $1.03 million for the
three months ended June 30, 2003 from $1.36 million for the three months ended
June 30, 2002. Average interest-bearing liabilities grew 12.9% to $251.6 million
for the second quarter of 2003 compared with $206.0 million for the second
quarter of 2002, while the average cost on interest-bearing liabilities
decreased to 1.64% from 2.42% for the same respective time periods. The decrease
in total interest expense and the average cost of interest-bearing liabilities
was due to the declining interest rate environment. Average certificates of
deposit balances for the second quarter of 2003 were $80.8 million at an average
cost of 2.70%, compared with $69.2 million at an average cost of 3.99% for the
same quarter one year earlier. Interest-bearing checking account deposits
averaged $50.9 million at an average cost of 0.20% for the June 2003 quarter,
compared with $46.6 million at an average cost of 0.44% for the June 2002
quarter. Interest-bearing money market and other savings deposits averaged
$100.8 million at an average cost of 0.94% for the quarter ended June 30, 2003,
compared with $90.2 million at an average cost of 1.72% for the same quarter one
year earlier. Average FHLB of Atlanta advances were $15.0 million at an average
cost of 4.64% for both the second quarter of 2003 and 2002.
12
The following table sets forth information relating to Bankshares' average
balance sheet and reflects the average yield on assets and the average
annualized cost of liabilities for the three month periods ended June 30, 2003
and 2002. Such yields and costs are derived by annualizing the income or expense
for the periods presented, and dividing the product of the annualizaton by the
respective average daily balances of assets and liabilities for the periods
presented.
AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(In Thousands)
3 Months Ending June 30, 2003 3 Months Ending June 30, 2002
--------------------------------- ----------------------------------
Average Income/ Average Average Income/ Average
Balances Expense Rate Balances Expense Rate
--------- --------- --------- --------- --------- ----------
ASSETS:
Loans
Taxable $ 229,329 $ 4,011 6.94% $ 209,001 $ 4,272 8.11%
Tax-exempt (1) 8,434 174 8.18% 5,433 111 8.11%
Nonaccrual 974 -- 0 852 -- 0.00%
--------- --------- --------- ---------
Total Loans 238,737 $ 4,186 6.96% 215,286 $ 4,383 8.08%
--------- --------- --------- ---------
Securities
Taxable 60,887 440 2.89% 45,296 523 4.61%
Tax-exempt (1) 1,657 28 6.72% 2,267 43 7.53%
--------- --------- --------- ---------
Total securities 62,544 $ 468 2.99% 47,563 $ 565 4.75%
--------- --------- --------- ---------
Deposits in banks 151 0 0.71% 80 0 1.71%
Federal funds sold 11,808 34 1.13% 13,776 58 1.66%
--------- --------- --------- ---------
Total earning assets 313,240 $ 4,688 5.94% 276,704 $ 5,007 7.19%
--------- ---------
Less: Reserve for loan losses (3,035) (2,939)
Cash and due from banks 16,372 15,414
Bank premises and equipment, net 7,528 6,453
Other assets 9,294 4,246
--------- ---------
Total Assets 343,399 299,879
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits
Demand deposits 62,259 50,305
Interest-bearing deposits
NOW accounts 50,939 25 0.20% 46,580 51 0.44%
Money market accounts 60,413 181 1.20% 52,819 257 1.95%
Savings accounts 40,383 55 0.54% 37,393 130 1.39%
Time deposits 80,800 544 2.70% 69,175 688 3.99%
--------- --------- --------- ---------
Total interest-bearing deposits 232,535 $ 805 1.39% 205,968 $ 1,126 2.19%
Federal funds purchased and securities sold under
agreements to repurchase -- -- -- -- -- --
Federal Home Loan Bank advances 15,000 176 4.64% 15,000 176 4.64%
Capital Securities of Subsidiary Trust 4,020 49 4.85% 4,021 56 5.56%
--------- --------- --------- ---------
Total interest-bearing liabilities 251,555 $ 1,030 1.64% 224,989 $ 1,358 2.42%
---------- --------- --------- ---------
Other liabilities 2,342 1,208
Shareholders' equity 27,243 23,378
--------- ---------
Total Liabilities & Shareholders' Equity $ 343,399 $ 299,879
========= =========
--------- ---------
Net interest spread $ 3,658 4.30% $ 3,648 4.77%
========= =========
Interest expense as a percent of average earning assets 1.32% 1.96%
Net interest margin 4.63% 5.22%
(1) Income and rates on non-taxable assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
13
The following table sets forth certain information regarding changes in interest
income and interest expense of Bankshares for the three month periods ended June
30, 2003 and 2002. 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 the prior period rate); and
changes in rate (change in rate multiplied by the prior period volume). Changes
which cannot be separately identified are allocated proportionately between
changes in volume and changes in rate.
RATE / VOLUME VARIANCE
(In Thousands)
Three Months Ending June 30, 2003 Compared to
Three Months Ending June 30, 2002
---------------------------------------------
Due to Due to
Change Volume Rate
-------- ------- --------
Loans; taxable $ (260) $ 538 $ (798)
Loans; tax-exempt (1) 63 62 1
Securities; taxable (82) 956 (1,039)
Securities; tax-exempt (1) (15) (11) (4)
Deposits in banks (0) -- --
Federal funds sold (24) (7) (17)
------- ------- -------
Total Interest Income (319) 1,538 (1,857)
------- ------- -------
INTEREST EXPENSE
NOW accounts (26) 5 (32)
Money market accounts (76) 45 (121)
Savings accounts (75) 12 (87)
Time deposits (142) 154 (296)
Federal funds purchased and securities
sold under agreements to repurchase -- 5 --
Federal Home Loan Bank Advances -- -- --
Capital Securities of Subsidiary Trust (6) -- (6)
------- ------- -------
Total Interest Expense (326) 216 (542)
------- ------- -------
Net Interest Income $ 7 $ 1,322 $(1,315)
======= ======= =======
(1) Income and rates on non-taxable assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
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 and
mortgage-backed securities, the reinvestment strategy for loan and
mortgage-backed security prepayments, the overall volume of interest-earning
assets and interest-bearing liabilities, and other factors. One trend that
resulted from the decrease in market interest rates that began in early 2001 and
continued throughout 2002 and into 2003 has been the increase in the magnitude
of loan and mortgage-backed security prepayments and the reduced yield on the
reinvestment of the prepayment proceeds. The continuation of this trend may
cause downward pressure on the net interest margin in future periods. The
monitoring and management of net interest income is the responsibility of TFB's
Asset and Liability Management Committee ("ALCO"). ALCO meets no less than once
a month, and is comprised of TFB's senior management.
PROVISION FOR LOAN LOSSES. The provision for loan losses was $155,000 and
$94,000 for the three months ended June 30, 2003 and 2002, respectively. The
respective amounts of the provision for loan losses were determined 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. There can be
no assurances, however, that future losses will not exceed estimated amounts, or
that additional provisions for loan losses will not be required in future
periods. The increase in loan loss provision when compared with $94,000 for the
June 2002 quarter, and with $75,000 for the March 2003 quarter, was necessitated
by applying the formula allowance methodology to the overall increase in TFB's
loan portfolio outstandings. Total loan outstandings increased $22.2 million
from March 31, 2003 to June 30, 2003, as compared to increases of $3.5 million
and $12.1 million from March 31, 2002 to June 30, 2002 and December 31, 2002 to
March 31, 2003, respectively. Please refer to the section entitled "Critical
Accounting Policies: Allowance for Loan Losses" above for an explanation of the
formula allowance methodology.
TOTAL OTHER INCOME. Total other income increased by $339,000 or 38.6% from
$877,000 for the three months ended June 30, 2002 to $1.22 million for the three
months ended June 30, 2003. This increase stemmed primarily from revenues
related to the continued growth of TFB's deposit base and retail banking
activities, as well as the increase of estate fees within TFB's Wealth
Management Services division, and the full quarter's income generated from the
February 28, 2003 purchase of bank-owned life insurance ("BOLI") totaling
$63,000. Service charges on deposit accounts increased $137,000, or 28.3% to
$620,000 for the quarter ended June 30, 2003, compared with $483,000 for the
same quarter one year earlier. A major factor in the increase in service charges
on deposit accounts was the impact of TFB's average demand deposit base
increasing 24.4% from $50.3 million for the June 30, 2002 quarter to $62.6
million for the June 30, 2003 quarter.
14
TOTAL OTHER EXPENSES. Total other expenses increased 11.4% or $338,000 to $3.30
million for the three months ended June 30, 2003, compared with $2.96 million
for the three months ended June 30, 2002. Salary and benefit expenses increased
$211,000, or 15.4% from the June 2002 quarter to the June 2003 quarter. The
primary causes of the increase in salary and benefit expense were increases in
the defined-benefit pension plan and medical insurance expense, as well as
customary annual salary increases. Occupancy and furniture and equipment
expenses also increased over the same time period by $33,000 and $47,000,
respectively. The increase in occupancy expense primarily reflects the increase
in rented office space for administrative personnel. The increase in furniture
and equipment expenses primarily reflects increases in the maintenance and
depreciation of computer software. Other operating expenses increased $46,000 or
4.0% largely due to the growth in expenses associated with TFB's merchant
bankcard program.
COMPARISION OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND JUNE
30, 2002
NET INCOME. Net income for the six months ended June 30, 2003 was $2.04 million
or $0.59 per diluted share compared with $1.88 million or $0.54 per diluted
share for the six months ended June 30, 2002. The 8.1% increase in net income
for the six-month period was primarily due to the increase in net interest
income and other income.
NET INTEREST INCOME. Net interest income increased $192,000 or 2.8% to $7.16
million for the six months ended June 30, 2003 compared with $6.97 million for
the six months ended June 30, 2002. The net interest margin, computed on a tax
equivalent basis, for the six month period through June 30, 2003 was 4.78%
compared with 5.21% for the same period one year earlier. The decrease in the
net interest margin can be primarily attributed to the declining interest rate
environment, and the corresponding reduction in the average rate on earning
assets, which declined on a tax equivalent basis to 6.14% for the six months
ended June 30, 2003, from 7.21% for the six months ended June 30, 2002.
Average interest-earning assets grew 12.4% to $303.9 million for the first half
of 2003 compared with $270.2 million for the first half of 2002. Total interest
income decreased $447,000 or 4.6% to $9.21 million for the six months ended June
30, 2003, compared with $9.66 million for the six months ended June 30, 2002, as
a result of the declining interest rate environment and its effect on the yield
on interest-earning assets. Interest and fees on loans decreased $466,000, or
5.4% to $8.10 million for the year-to-date period ended June 30, 2003. Average
loans outstanding totaled $230.2 million and earned 7.13% on a tax-equivalent
basis for the six months ended June 30, 2003, compared with $214.3 million and
8.05%, respectively, for the six months ended June 30, 2002. Investment
securities income increased $83,000 or 8.4%, while interest on federal funds
sold decreased $64,000 or 63.7%. Investment securities and federal funds sold
averaged $67.1 million and $6.5 million, respectively, for the first six months
of 2003 compared with $43.5 million and $12.4 million for the same period one
year earlier. The yield on investment securities and federal funds was 3.06% on
a tax-equivalent basis for the first six months of 2003, compared with 4.00% for
the first six months of 2002.
Total interest expense decreased $640,000 or 23.8% to $2.05 million for the six
months ended June 30, 2003 from $2.69 million for the six months ended June 30,
2002. Average interest-bearing liabilities grew 11.9% to $244.5 million for the
first half of 2003 compared with $218.6 million for the first half of 2002,
while the average cost on interest-bearing liabilities decreased to 1.69% from
2.48% for the same respective time periods. The decrease in total interest
expense and the average cost of interest-bearing liabilities was due to the
declining interest rate environment. Average certificates of deposit balances
for the first six months of 2003 were $76.5 million at an average cost of 2.79%,
compared with $69.0 million at an average cost of 4.15% for the same period one
year earlier. Interest-bearing checking account deposits averaged $49.1 million
at an average cost of 0.22% for the year to date through June 2003, compared
with $45.0 million at an average cost of 0.44% for the same period one year
earlier. Interest-bearing money market and other savings deposits averaged $99.2
million at an average cost of 0.99% for the six months ended June 30, 2003,
compared with $87.5 million at an average cost of 1.76% for the same period one
year earlier. Average FHLB of Atlanta advances were $15.0 million at an average
cost of 4.64% for both the first six months of 2003 and 2002.
15
The following table sets forth information relating to Bankshares' average
balance sheet and reflects the average yield on assets and the average
annualized cost of liabilities for the six month periods ended June 30, 2003 and
2002. Such yields and costs are derived by annualizing the income or expense for
the periods presented, and dividing the product of the annualizaton by the
respective average daily balances of assets and liabilities for the periods
presented.
AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(In Thousands)
Six Months Ending June 30, 2003 Six Months Ending June 30, 2002
--------------------------------- ----------------------------------
Average Income/ Average Average Income/ Average
Balances Expense Rate Balances Expense Rate
--------- --------- --------- --------- --------- ----------
ASSETS:
Loans
Taxable $ 220,943 $ 7,878 7.11% $ 208,003 $ 8,426 8.08%
Tax-exempt (1) 8,352 344 8.20% 5,391 220 8.12%
Nonaccrual 933 -- 0.00% 870 -- 0.00%
--------- --------- --------- ---------
Total Loans 230,227 8,222 7.13% 214,264 8,646 8.05%
--------- --------- --------- ---------
Securities
Taxable 65,323 1,030 3.15% 40,742 921 4.52%
Tax-exempt (1) 1,689 58 6.82% 2,633 95 7.19%
--------- --------- --------- ---------
Total securities 67,012 1,087 3.25% 43,376 1,016 4.69%
--------- --------- --------- ---------
Deposits in banks 134 1 1.10% 165 2 1.94%
Federal funds sold 6,480 37 1.13% 12,435 101 1.62%
--------- --------- --------- ---------
Total earning assets 303,853 9,347 6.14% 270,238 9,764 7.21%
--------- --------- --------- ---------
Less: Reserve for loan losses (3,009) (2,906)
Cash and due from banks 16,948 15,414
Bank premises and equipment, net 7,014 6,453
Other assets 7,437 4,256
--------- ---------
Total Assets 332,243 293,456
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Deposits
Demand deposits 58,887 48,540
Interest-bearing deposits
NOW accounts 49,067 54 0.22% 45,006 99 0.44%
Money market accounts 59,219 372 1.27% 51,085 511 2.02%
Savings accounts 39,954 114 0.58% 36,383 253 1.40%
Time deposits 76,526 1,057 2.79% 68,969 1,419 4.15%
--------- --------- --------- ---------
Total interest-bearing deposits 224,766 1,597 1.43% 201,444 2,282 2.28%
--------- --------- --------- ---------
Federal funds purchased and securities sold under
agreements to repurchase 739 5 1.47% -- -- 0.00%
Federal Home Loan Bank advances 15,000 350 4.64% 15,000 350 4.64%
Capital Securities of Subsidiary Trust 4,018 99 4.98% 2,154 60 5.58%
--------- --------- --------- ---------
Total interest-bearing liabilities 244,523 2,051 1.69% 218,598 2,691 2.48%
--------- --------- --------- ---------
Other liabilities 1,858 1,952
Shareholders' equity 26,975 24,366
--------- ---------
Total Liabilities & Shareholders' Equity $332,243 $ 293,456
========= =========
--------- ---------
Net interest spread $ 7,295 4.45% $ 7,073 4.73%
========= =========
Interest expense as a percent of average earning assets 1.36% 2.00%
Net interest margin 4.78% 5.21%
(1) Income and rates on non-taxable assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
16
The following table sets forth certain information regarding changes in interest
income and interest expense of Bankshares for the six month periods ended June
30, 2003 and 2002. 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 the prior period rate); and
changes in rate (change in rate multiplied by the prior period volume). Changes
which cannot be separately identified are allocated proportionately between
changes in volume and changes in rate.
RATE / VOLUME VARIANCE
(In Thousands)
Six Months Ending June 30, 2003 Compared to
Six Months Ending June 30, 2002
-------------------------------------------
Due to Due to
Change Volume Rate
------- ------- --------
INTEREST INCOME
Loans; taxable $ (548) $ 583 $(1,131)
Loans; tax-exempt (1) 124 122 2
Securities; taxable 108 216 (108)
Securities; tax-exempt (1) (37) (32) (5)
Deposits in banks (1) -- (1)
Federal funds sold (64) (40) (25)
------- ------- -------
Total Interest Income (418) 849 (1,268)
------- ------- -------
INTEREST EXPENSE
NOW accounts (45) 10 (55)
Money market accounts (139) 105 (244)
Savings accounts (139) 28 (167)
Time deposits (362) 180 (542)
Federal funds purchased and securities
sold under agreements to repurchase 5 5 --
Federal Home Loan Bank advances -- -- --
Capital Securities of Subsidiary Trust 41 47 (6)
------- ------- -------
Total Interest Expense (639) 375 (1,014)
------- ------- -------
Net Interest Income $ 220 $ 474 $ (254)
======= ======= =======
(1) Income and rates on non-taxable assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
PROVISION FOR LOAN LOSSES. The provision for loan losses was $230,000 and
$188,000 for the six months ended June 30, 2003 and 2002, respectively. The
respective amounts of the provision for loan losses were determined based upon
management's continual evaluation as described in the "Comparison of Operating
Results for the Three Months Ended June 30, 2003 and June 30, 2002."
TOTAL OTHER INCOME. Total other income increased by $544,000 or 30.1% from $1.81
million for the six months ended June 30, 2002 to $2.35 million for the six
months ended June 30, 2003, primarily due to the same factors discussed in the
"Comparison of Operating Results for the Three Months Ended June 30, 2003 and
June 30, 2002." Service charges on deposit accounts increased $297,000, or 31.0%
to $1.25 million for the six months ended June 30, 2003, compared with $955,000
for the same period one year earlier. A major factor in the increase in service
charges on deposit accounts was the impact of TFB's average demand deposit base
increasing 21.3% from $48.5 million for the six months ended June 30, 2002 to
$58.9 million for the six months ended June 30, 2003.
TOTAL OTHER EXPENSES. Total other expenses increased 8.9% or $524,000 to $6.38
million for the six months ended June 30, 2003, compared with $5.86 million for
the six months ended June 30, 2002. Salary and benefit expenses increased
$401,000, or 14.5% from the first half of 2002 to the first half of 2003. The
primary factors causing the increase in salary and benefit expense were
increases in the defined-benefit pension plan and medical insurance expense, and
customary annual salary increases. Occupancy and furniture and equipment
expenses also increased over the same period by $69,000 and $94,000,
respectively. The increase in occupancy expense primarily reflects the increased
snow removal expenses resulting from the severe winter of January through March
2003 compared to the same period in 2002, as well as an increase in rented
office space for administrative personnel. The increase in furniture and
equipment expenses primarily reflects increases in the maintenance and
depreciation of computer software. Other operating expenses decreased $40,000 or
1.8% largely due to a decline in marketing expense. During the first quarter of
2002, TFB celebrated its centennial anniversary year, which added approximately
$42,000 to the 2002 marketing expenses. These centennial expenses did not
reoccur in the first quarter of 2003.
COMPARISON OF JUNE 30, 2003 AND DECEMBER 31, 2002 FINANCIAL CONDITION
Assets totaled $368.5 million at June 30, 2003, an increase of 14.6% or $47.0
million from $321.5 million at December 31, 2002. Balance sheet categories
reflecting significant changes include loans, federal funds sold, securities,
other assets, and deposits. Each of these categories is discussed below.
LOANS. Net loans were $248.0 million at June 30, 2003, which is an increase of
$34.3 million or 16.0% from $213.7 million at December 31, 2002. The growth in
total loans is primarily attributable to an increase in mortgage loans on 1-to-4
family residential real estate of $11.3 million, an increase in mortgage loans
on commercial real estate of $7.6 million, an increase in commercial and
industrial loans of $5.6
17
million, an increase in construction and land development loans of $3.5 million,
and an increase in consumer installment loans of $3.5 million.
FEDERAL FUNDS SOLD. Federal funds sold were $21.1 million at June 30, 2003,
compared with $4.9 million at December 31, 2002, representing an increase of
$16.2 million. The increase in federal funds sold primary reflects the overnight
investment of a one-day inflow of demand deposits that were transferred from TFB
on July 1, 2003.
SECURITIES. Investment securities decreased $6.0 million from December 31, 2002
to June 30, 2003. This decrease reflects the contractual repayment and
prepayment of principal on government agency and private-issue securities
collateralized by residential mortgage loans.
OTHER ASSETS. Other assets increased $5.3 million from December 31, 2002 to June
30, 2003. On February 28, 2003, TFB purchased $5 million of BOLI policies on
certain key executives. BOLI is recorded at its cash surrender value, or the
amount that can be realized. At June 30, 2003, the cash surrender value of BOLI
was $5,084,000.
DEPOSITS. At June 30, 2003, total deposits were $319.5 million, reflecting an
increase of $45.9 million or 16.8% from $273.7 million at December 31, 2002. The
growth was attributable to growth in interest-bearing deposits, which increased
$19.7 million, and growth in noninterest-bearing deposits, which increased $26.2
million. Approximately $18.8 million of the increase in noninterest-bearing
deposits reflects a one-day inflow of demand deposits that were transferred from
TFB on July 1, 2003. Several factors may have contributed to the increase in
interest-bearing deposits, including the outflow of funds from the equity
investment markets into bank deposits, as well as the local market reaction to
the consolidation of former community banks into non-locally based regional
banks.
SHAREHOLDERS' EQUITY
Total shareholders' equity was $27.4 million at June 30, 2003 compared to $26.4
million at December 31, 2002, an increase of $947,000, or 3.6%. During the six
months ended June 30, 2003, shareholders' equity was reduced by $154,000 due to
the repurchase of 9,900 shares of Bankshares' common stock.
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 $1.0 million, or 0.40% of total loans
at June 30, 2003, as compared with $850,000, or 0.39% of total loans at December
31, 2002, and $1.3 million, or 0.61% of total loans at June 30, 2002.
Non-performing loans as a percentage of the allowance for loan losses were
32.3%, 29.2%, and 44.5% at June 30, 2003, December 31, 2002, and June 30, 2002,
respectively.
Loans that are 90 days past due and accruing interest totaled $265,000 and
$244,000 at June 30, 2003 and December 31, 2002, respectively. No loss is
anticipated on these loans.
There are no loans, other than those disclosed above as either non-performing or
impaired, where known information about the borrower has caused management to
have serious doubts about the borrower's ability to repay the loan. There are
also 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
TFB's primary sources of funds are deposits, repayment of loans, maturities of
investments, funds provided
18
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 funds for existing and future loan commitments, maturing certificates
of deposit and demand deposit withdrawals, to invest in other interest-earning
assets, to maintain liquidity, and to meet operating expenses. Management
regularly 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, interest-bearing deposits in
other banks and federal funds sold totaled $36.8 million at June 30, 2003. These
assets provide the primary source of liquidity for TFB. In addition, management
has designated the investment securities portfolio, totaling $65.8 million, as
available for sale, and TFB has a line of credit with the FHLB of Atlanta to
provide additional sources of liquidity. The FHLB of Atlanta line of credit had
a borrowing limit of approximately $52.7 million at June 30, 2003, of which
$15.0 million was in use.
CAPITAL REQUIREMENTS
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 1 Capital (as defined in the regulations) to
risk-weighted assets (as defined in the regulations), and of Tier 1 Capital to
average assets (as defined in the regulations). As the table below illustrates,
Bankshares and TFB exceeded their regulatory capital requirements as of June 30,
2003.
MINIMUM TO BE WELL
(Amount in thousands except ratios) CAPITALIZED UNDER
MINIMUM CAPITAL PROMPT CORRECTIVE
ACTUAL REQUIREMENT ACTION PROVISIONS
----------------- ----------------- ------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ------ ------- ------ ------- ------
As of June 30, 2003:
Total Capital (to Risk-Weighted
Assets):
Consolidated $33,979 13.85% $19,627 8.00% N/A N/A
The Fauquier Bank $34,036 13.87% $19,631 8.00% $24,539 10.00%
Tier 1 Capital (to Risk-Weighted Assets):
Consolidated $30,911 12.60% $ 9,813 4.00% N/A N/A
The Fauquier Bank $30,968 12.62% $ 9,816 4.00% $14,724 6.00%
Tier 1 Capital (to Average
Assets):
Consolidated $30,911 9.00% $13,739 4.00% N/A N/A
The Fauquier Bank $30,968 9.02% $13,733 4.00% $17,166 5.00%
19
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts(collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement is effective for contracts
entered into or modified after June 30, 2003 and is not expected to have an
impact on Bankshares' consolidated financial statements.
In May 2003, FASB issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This Statement
establishes standards for classifying and measuring certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those instruments were
previously classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003, except for mandatory redeemable financial instruments of nonpublic
entities. Adoption of the Statement did not result in an impact on Bankshares'
consolidated financial statements.
SUBSEQUENT EVENT
On or about July 16, 2003, TFB sold $10 million of available-for-sale Government
Agency and Corporate securities, whose weighted-average remaining maturity was
approximately one year, for gain on sale of $288,000, and reinvested the
proceeds from the sale into available-for-sale Government Agency securities with
a weighted-average remaining maturity of approximately four years. The gain on
sale will be reflected in Bankshares' Consolidated Statements of Income during
the quarter ending September 30, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
An important component of both earnings performance and liquidity is the
management of interest rate sensitivity. Interest rate sensitivity reflects the
potential effect on net interest income of a movement 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 interest rate risk is best measured by
simulation modeling. The simulation model generates a forecast of 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 change in market rates of up to 200 basis
points up or down. TFB's policy limits for the maximum negative impact on net
interest income and change in the economic value of equity resulting from
instantaneous change in market interest rates of 200 basis points are 15% and
35%, respectively. Management has maintained a risk position well within these
guideline levels during the second quarter of 2003.
There have been no material changes in market risk since the 2002 year end.
20
ITEM 4. 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 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
Exchange 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.
Bankshares has 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. The chief
executive officer and chief financial officer evaluated the effectiveness of
these disclosure controls and procedures as of the end of the period covered by
this report and, based on this evaluation, 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 control over financial
reporting during the most recent fiscal quarter that have materially affected,
or are reasonably likely to materially-affect Bankshares' internal control over
financial reporting.
Part II. OTHER INFORMATION
ITEM 1. 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Bankshares held its Annual Meeting of Shareholders on May 20, 2003. A quorum of
Shareholders was present, consisting of a total of 2,590,269 shares, all
represented by proxy. At the Annual Meeting, the Shareholders elected Class I
directors C. H. Lawrence, Jr., John J. Norman, Jr. and C. Hunton Tiffany to
three-year terms. The following Class II and Class III directors whose terms
expire in 2004 and 2005 continued in office: Alexander G. Green, Jr., Stanley C.
Haworth, Douglas C. Larson, D. Harcourt Lees, Jr., Randolph T. Minter, Brian S.
Montgomery, Harold P. Neale, Pat H. Nevill, and H. Frances Stringfellow. The
Shareholders also ratified the appointment of Yount, Hyde & Barbour, P.C. as
independent auditors of the Bank for the year ending December 31, 2003.
21
The vote on each matter was as follows:
1. For Directors:
FOR WITHHELD
--- --------
C. H. Lawrence, Jr. 2,514,261 76,008
John J. Norman, Jr. 2,496,986 93,283
C. Hunton Tiffany 2,515,461 74,808
2. Ratification of the appointment of Yount, Hyde & Barbour, P.C. as the
independent auditors for Bankshares and TFB:
FOR AGAINST ABSTAIN
--- ------- -------
2,509,713 68,356 13,800
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
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
10.13 Form of Executive Survivor Income Agreement, dated on or about dated
May 9, 2003, between The Fauquier Bank and each of C. Hunton
Tiffany, Randy K. Ferrell, Gary R. Shook, Eric P. Graap and Roseanne
T. Gorkowski
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.
11 Refer to Part I, Item 1, Footnote 5 to the Consolidated Financial
Statements.
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
32.1 Certification Pursuant to 18 U.S.C. Section 1350 of Chief Executive
Officer
32.2 Certification Pursuant to 18 U.S.C. Section 1350 of Chief Financial
Officer
22
(b) Reports on Form 8-K:
Current Report on Form 8-K, filed on April 21, 2003, attaching a press release
announcing Bankshares' results of operations for the quarter ended March 31,
2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FAUQUIER BANKSHARES, INC.
(REGISTRANT)
Dated: August 14, 2003 /s/ C. Hunton Tiffany
--------------------------------------------------
C. Hunton Tiffany
Chairman and Chief Executive Officer
(principal executive officer)
Dated: August 14, 2003 /s/ Randy K. Ferrell
--------------------------------------------------
Randy K. Ferrell
President and Chief Operating Officer
Dated: August 14, 2003 /s/ Eric P. Graap
--------------------------------------------------
Eric P. Graap
Senior Vice President and Chief Financial Officer
(principal financial and accounting officer)
23