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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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 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 stock 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 30, 2003, was
$45,450,265. Shares held by each officer, director and holder of 10% or more of
the registrant's outstanding common stock have been excluded as shares held by
affiliates. Such determination of affiliate status is not a conclusive
determination for other purposes.
The registrant had 3,304,732 shares of common stock outstanding as of March 17,
2004.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement for the 2004 Annual Meeting of
Shareholders to be held on May 18, 2004 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 8
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
Executive Officers of the Registrant 9
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters 10
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation 10
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 31
Item 8. Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 34
Item 9A. Controls and Procedures 34
PART III
Item 10. Directors and Executive Officers of the Registrant 34
Item 11. Executive Compensation 35
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Item 12. Security Ownership of Certain Beneficial Owners and Management 35
Item 13. Certain Relationships and Related Transactions 35
Item 14. Principal Accounting Fees and Services 36
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 36
Audited Consolidated Financial Statements
ii
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
3,312,230 shares of common stock, par value $3.13 per share, held by
approximately 387 holders of record on December 31, 2003.
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 purchased a
property in Bealeton, Virginia, and has begun building its eighth full-service
branch office scheduled to open during the first half of 2004.
THE FAUQUIER BANK
TFB's general market area principally includes Fauquier County, western Prince
William County, and neighboring communities and is located approximately fifty
(50) 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 division ("WMS") 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. TFB 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.
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.
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
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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, 2003, Bankshares had total consolidated assets of $378.5
million, total consolidated deposits of $321.1 million, and total consolidated
shareholders' equity of $28.5 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, 2003 were $295.3 million, or 78.0% 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 7.0% and 13.9% of TFB's loan
portfolio at December 31, 2003 consisted of commercial and consumer loans,
respectively. The majority of TFB's loans are made on a secured basis. As of
December 31, 2003, approximately 74.8% of the loan portfolio consisted of loans
secured by mortgages on real estate. Income from loans remained steady at $17.2
million for 2003 compared with $17.2 million for 2002.
LOANS SECURED BY REAL ESTATE
ONE TO FOUR ("1-4") FAMILY RESIDENTIAL LOANS. TFB's 1-4 family residential
mortgage loan portfolio consists of conventional loans, primarily with fixed
interest rates with 15 or 30 year terms, and balloon loans with fixed interest
rates, and 3, 5, 7, or 10-year maturities but utilizing amortization schedules
of 30 years or less. As of December 31, 2003, TFB's conventional 1-4 family
residential loans amounted to $119.1 million, or 39.8% 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. TFB requires private
mortgage insurance ("PMI") if the principal amount of the loan exceeds 80% of
the value of the property held as collateral.
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 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 construction loans are to selected local developers 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, 2003, TFB's construction loans totaled $21.2 million, or 7.1% of
the total loan portfolio.
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COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate comprised
$81.9 million, or 27.4% of total loans at December 31, 2003, 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. Approximately 93% of these loans, on a
dollar-value basis, are for terms of six years or less, and are secured by liens
on automobles of the borrowers. The remaining consumer loans are either secured
by other personal assets of the borrower, or made on an unsecured basis.
Consumer loans are made at fixed and variable rates, and are often based on up
to a six-year amortization schedule. The consumer loan portfolio was $41.4
million or 13.9% of total loans at December 31, 2003.
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 approximately 79% of TFB's commercial loans, on a
dollar-value basis, with the remainder of commercial loans 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 originating and keeping loans on TFB's
balance sheet. These include interest rate and 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. The commercial
loan portfolio was $21.1 million or 7.0% of total loans at December 31, 2003.
DEPOSIT ACTIVITIES
Deposits are the major source of TFB's funds for lending and other investment
activities. TFB considers its regular savings, demand, NOW and money market
deposit accounts to be core deposits. These accounts comprised approximately
75.3% of TFB's total deposits at December 31, 2003. Approximately 24.7% of TFB's
deposits at December 31, 2003 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 9.4% of TFB's total deposits
at December 31, 2003. Historically, time deposits of $100,000 and over have
generally paid 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.
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INVESTMENTS
TFB invests a portion of its assets in U.S. Treasury and U.S.
Government-sponsored 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 $52.4 million, or 13.8% of total assets at December 31, 2003. Income from
investments in 2003 totaled $2.2 million, consisting of $1.9 million in interest
and dividends and $248,000 in gain on sale. In 2002, income from investments
totaled $2.1 million and consisted of $2.1 million in interest and dividends and
$34,000 in gain on sale.
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.
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.
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 Commission (the "SEC"). As an Exchange Act
reporting company, Bankshares is directly affected by the 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 effect on its operations in the near-term. However,
to the extent that the Act permits banks, securities firms and insurance
companies to affiliate with each other, 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 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.
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.
As a bank, TFB is also subject to the provisions of the Community Reinvestment
Act of 1977 ("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.
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 to Bankshares.
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
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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, 2003, TFB had a
total risk-based capital ratio of 12.7% and a Tier 1 risk-based capital ratio of
11.5%, and Bankshares had a total risk-based capital ratio of 12.8% and a Tier 1
risk-based capital ratio of 11.5%.
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 4.0% for banks and bank holding companies. As of December 31,
2003, TFB had a leverage ratio of 8.6%, and Bankshares had a leverage ratio of
8.6%.
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
which have total assets of $250 million or more. Annual full-scope, on-site
regulatory 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.
FDICIA also 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 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%, 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, 2003, both Bankshares and TFB were
considered "well capitalized."
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. In addition, TFB is
required to pledge collateral for outstanding advances. The borrowing agreement
with the FHLB of Atlanta provides for the pledge by TFB of various forms of
securities and mortgage loans as collateral. Borrowers pledging mortgage
collateral must maintain, at all times, possession
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and/or control of the original legal documents (i.e., note and mortgage).
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. The 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.
EMPLOYEES
As of December 31, 2003, Bankshares and TFB employed 112 full-time employees and
25 part-time employees compared with 101 full-time and 25 part-time employees as
of December 31, 2002. No employee is represented by a collective bargaining
unit. Bankshares and TFB consider relations with employees to be good.
AVAILABLE INFORMATION
Bankshares files annual, quarterly and current reports, proxy statements and
other information with the SEC. Bankshares' SEC filings are filed electronically
and are available to the public over the internet at the SEC's website at
http://www.sec.gov. In addition, any document filed by Bankshares with the SEC
can be read and copied at the SEC's public reference facilities at 450 Fifth
Street, N.W., Washington, D.C. 20549. Copies of documents can be obtained at
prescribed rates by writing to the Public Reference Section of the SEC at 450
Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on
the operation of the Public Reference Room by calling 1-800-SEC-0330.
Bankshares' website is http://www.fauquierbank.com, and Bankshares' SEC filings
are available through this website. Copies of documents can also be obtained
free of charge by writing to Secretary, Fauquier Bankshares, Inc. at 10
Courthouse Square, Warrenton, Virginia 20186 or by calling 540-347-2700.
7
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**
US Rt. 17 & Station Dr. Own N/A N/A N/A
Bealeton, VA 22712
- ---------------------------------------------------------------------------------------------------------------
*TFB and Bankshares occupy this location.
**Currently under construction; branch scheduled to open during the first
half of 2004.
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.
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, 2003.
8
EXECUTIVE OFFICERS OF THE REGISTRANT
FIRST YEAR AS
POSITION HELD WITH COMPANY AND/OR PRINCIPAL EXECUTIVE AGE AS OF
OCCUPATIONS AND DIRECTORSHIPS DURING THE PAST OFFICER OF DECEMBER
NAME FIVE YEARS COMPANY 31, 2003
---- ---------- ------- --------
C. Hunton Tiffany Chairman of the Board of Bankshares since 1996. 1984 64
Chief Executive Officer of Bankshares since 1984.
President of Bankshares from 1984 to May 2003.
Chairman of the Board of TFB since 1996. Chief
Executive Officer of TFB from 1982 to May 2003.
President of TFB from 1982 to January 2002.
Director of Bankshares since 1984. Director of TFB
since 1974.
Randy K. Ferrell President and Chief Operating Officer of Bankshares 1994 53
since May 2003. Senior Vice President of Bankshares
from 1994 to May 2003. Chief Executive Officer of TFB
since May 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. Director of
Bankshares since December 2003. Director of TFB since
2002.
Gary R. Shook Senior Vice President of Bankshares and TFB, Wealth 1995 43
Management Services, since 1995.
Rosanne T. Gorkowski Senior Vice President of TFB, Human Resources and 2000 58
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 Officer of 2000 50
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 since 2002 38
2002. Vice President of TFB from 1998 to 2002.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Bankshares' common stock is traded over the counter on the National Association
of Securities Dealers Automated Quotation ("NASDAQ") SmallCap Market System
under the symbol "FBSS". Bankshares' common stock commenced trading on
December 27, 1999.
As of December 31, 2003, there were 3,312,230 shares outstanding of Bankshares'
common stock, which is Bankshares' only class of stock outstanding. These shares
were held by approximately 387 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.
2003 2002 Dividends per share
------------------ ------------------ -------------------
High Low High Low 2003 2002
-------- ------- -------- ------- --------- -------
1st Quarter $ 17.49 $ 14.35 $ 13.50 $ 12.06 $ 0.11 $ 0.10
2nd Quarter $ 17.53 $ 15.50 $ 16.35 $ 13.25 $ 0.12 $ 0.10
3rd Quarter $ 18.52 $ 17.16 $ 15.10 $ 13.91 $ 0.12 $ 0.10
4th Quarter $ 22.95 $ 18.20 $ 16.90 $ 14.42 $ 0.13 $ 0.11
All amounts in the table above have been restated to reflect the two-for-one
stock split 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, 2003, the aggregate amount of unrestricted funds that could be
transferred from TFB to Bankshares without prior regulatory approval totaled
$5.7 million.
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) 2003 2002 2001 2000 1999
EARNINGS STATEMENT DATA:
Interest income $ 19,136 $ 19,496 $ 19,785 $ 18,002 $ 17,129
Interest expense 4,001 5,082 7,221 6,084 6,043
----------- ----------- ----------- ----------- -----------
Net interest income 15,135 14,414 12,564 11,918 11,086
Provision for loan losses 784 346 350 457 695
----------- ----------- ----------- ----------- -----------
Net interest income after
provision for loan losses 14,351 14,068 12,214 11,461 10,391
Noninterest income 4,780 3,866 3,836 2,842 2,433
Securities gains (losses) 248 34 -- (111) --
Noninterest expense 13,222 12,296 10,938 9,665 9,023
----------- ----------- ----------- ----------- -----------
Income before income taxes 6,157 5,672 5,112 4,527 3,801
Income taxes 1,821 1,742 1,597 1,430 1,162
----------- ----------- ----------- ----------- -----------
Net income $ 4,336 $ 3,930 $ 3,515 $ 3,097 $ 2,639
=========== =========== =========== =========== ===========
PER SHARE DATA: (1)
Net income per share, basic 1.31 1.18 1.03 0.88 0.73
Net income per share, diluted 1.24 1.14 1.01 0.88 0.73
Cash dividends 0.48 0.41 0.36 0.32 0.28
Average basic shares outstanding 3,308,124 3,312,084 3,406,866 3,510,364 3,604,330
Average diluted shares outstanding 3,480,588 3,460,128 3,473,696 3,533,546 3,636,264
Book value at period end 8.59 8.00 7.21 6.55 5.98
BALANCE SHEET DATA:
Total Assets $ 378,460 $ 321,499 $ 285,202 $ 249,855 $ 233,208
Loans, net 295,312 213,698 207,453 197,879 181,503
Investment securities 52,386 71,737 36,908 16,956 18,779
Deposits 321,129 273,668 243,747 212,103 187,273
Shareholders' equity 28,463 26,431 24,157 22,419 21,204
PERFORMANCE RATIOS:
Net interest margin(2) 4.80% 5.24% 5.02% 5.56% 5.35%
Return on average assets 1.24% 1.29% 1.28% 1.32% 1.14%
Return on average equity 15.84% 15.74% 14.73% 14.13% 12.50%
Dividend payout 35.08% 34.51% 34.76% 36.09% 34.34%
Efficiency ratio(3) 65.17% 66.44% 65.78% 64.69% 63.51%
ASSET QUALITY RATIOS:
Allowance for loan losses to period
end loans, net 1.20% 1.34% 1.36% 1.27% 1.24%
Nonperforming loans to allowance for
loan losses 27.06% 29.20% 31.96% 4.74% 5.49%
Non-performing assets to period end loans
and other real estate owned 0.33% 0.39% 0.43% 0.06% 0.07%
Net charge-offs to average loans 0.04% 0.14% 0.02% 0.10% 0.15%
CAPITAL RATIOS:
Leverage 8.58% 9.35% 8.30% 9.13% 8.80%
Risk Based Capital Ratios:
Tier 1 capital 11.51% 14.26% 12.00% 11.96% 12.20%
Total capital 12.76% 15.52% 13.25% 13.21% 13.40%
(1) Amounts have been restated to reflect a two-for-one stock split 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.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
FORWARD-LOOKING STATEMENTS
In addition to the historical information contained herein, this report contains
forward-looking statements. 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,
10
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
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 in this report, and you should not place
undue reliance on such statements, which reflect our position as of the date of
this report.
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.
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 1-4 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.
11
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.
EXECUTIVE OVERVIEW
This discussion is intended to focus on certain financial information regarding
Bankshares and TFB and may not contain all the information that is important to
the reader. The purpose of this discussion is to provide the reader with a more
thorough understanding of our financial statements. As such, this discussion
should be read carefully in conjunction with the consolidated financial
statements and accompanying notes contained elsewhere in this report.
Through merger and consolidation, TFB has become the primary independent
community bank in its immediate market area. It continually seeks to be the
primary financial service provider for its market area by providing the right
mix of high quality customer service, efficient technological support,
value-added products, and a strong commitment to the community.
Net income of $4.3 million in 2003 was a 10% increase from 2002 net income of
$3.9 million. Bankshares and TFB experienced growth across all of its primary
operating businesses, with growth in commercial and retail lending, deposit
accounts and core deposits, and assets under WMS management. During 2003, TFB
modified its loan pricing strategies and expanded its loan product offerings in
an effort to increase lending activity without sacrificing the existing credit
quality standards. The result of this was a 38% increase in net loan
outstandings in 2003. Deposits increased 17% from year-end 2002 to year-end
2003, with TFB gaining in-market customers who grew dissatisfied with the
service and pricing resulting from the consolidation of other local community
banks into larger, out-of-market financial institutions. Assets under management
grew by $48 million to $219 million, or 28%, from 2002, with revenue increasing
from $694,000 to $936,000, or 34.7%, as management focused more people,
marketing, and other resources toward its WMS business.
Net interest income is the largest component of net income, and equals the
difference between income generated on interest-earning assets and interest
expense incurred on interest-bearing liabilities. 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 2004 and beyond as
average interest-earning assets increase, but this may be offset in part or in
whole by a possible contraction in TFB's net interest margin resulting from
competitive market conditions. Additionally, TFB's balance sheet is positioned
for a stable or rising interest rate environment. This means that net interest
is projected to increase if market interest rates rise, and to decrease if
market interest rates fall. The specific nature of TFB's variability in net
interest income due to changes in interest rates, also known as interest rate
risk, is to a large degree the result of TFB's deposit base structure. During
2003, demand deposits, NOW, and savings deposits averaged 21%, 18%, and 14% of
total average deposits, respectively, while the more interest-rate sensitive
time certificates of deposit averaged 27% of total average deposits.
TFB continues to have strong credit quality as evidenced by non-performing loans
totaling $967,000 or 0.33% of total loans at December 31, 2003, as compared with
$850,000, or 0.39% of total loans at December 31, 2002. The provision for loan
losses was $784,000 for 2003 compared with $346,000 for 2002. The 126.6%
increase in the provision for loan losses from 2002 to 2003 was largely in
response to the growth in new loan originations during 2003, and, to a lesser
extent, the continued uncertainty existing in the economic and geopolitical
environment.
Management continues the expansion of its branch network into southern Fauquier
County with a new branch scheduled to open in Bealeton, Virginia during the
first half of 2004. Additionally, TFB looks to add to its
12
branch network in western Prince William County. TFB is looking toward these new
retail markets for growth in deposits and WMS income. Management also seeks to
increase the level of its fee income from deposits and WMS through the increase
of its market share within its marketplace.
The following table presents a quarterly summary of earnings for the last two
years. In 2003, earnings exhibited an increasing profitability from recurring
sources when compared with the same quarter from the prior year, primarily the
result of the steady and continuous growth in net interest income and fees on
deposits.
EARNINGS
(In Thousands)
Three Months Ended 2003 Three Months Ended 2002
---------------------------------- ---------------------------------
DEC. 31 SEP. 30 JUNE 30 MAR. 31 DEC. 31 SEP. 30 JUNE 30 MAR. 31
------- ------- ------- ------- --------------- ------- -------
Interest income $5,160 $4,766 $4,619 $4,591 $4,951 $4,888 $4,954 $4,703
Interest expense 994 956 1,030 1,021 1,128 1,264 1,358 1,332
------ ------ ------ ------ ------ ------ ------ ------
Net Interest Income 4,166 3,810 3,589 3,570 3,823 3,624 3,596 3,371
Provision for loan losses 314 240 155 75 93 65 94 94
------ ------ ------ ------ ------ ------ ------ ------
Net interest income after
provision for loan losses 3,852 3,570 3,434 3,495 3,730 3,559 3,502 3,277
Other Income 1,227 1,492 1,215 1,134 1,096 999 877 928
Other Expense 3,546 3,334 3,300 3,082 3,385 3,054 2,963 2,895
------ ------ ------ ------ ------ ------ ------ ------
Income before income taxes 1,533 1,728 1,349 1,547 1,441 1,504 1,416 1,310
Income tax expense 440 522 403 456 426 473 444 398
------ ------ ------ ------ ------ ------ ------ ------
Net income $1,093 $1,206 $ 946 $1,091 $1,015 $1,031 $ 972 $ 912
====== ====== ====== ====== ====== ====== ====== ======
Net income per share, basic $ 0.33 $ 0.36 $ 0.28 $ 0.33 $ 0.31 $ 0.31 $ 0.29 $ 0.27
Net income per share, diluted $ 0.31 $ 0.34 $ 0.27 $ 0.32 $ 0.29 $ 0.30 $ 0.28 $ 0.27
RESULTS OF OPERATIONS
2003 COMPARED TO 2002
Net income of $4.3 million in 2003 was a 10.3% increase from 2002 net income of
$3.9 million. Earnings per share (EPS) on a fully diluted basis were $1.24 in
2003 compared to $1.14 in 2002. Profitability as measured by return on average
equity increased from 15.7% in 2002 to 15.8% in 2003. Profitability as measured
by return on average assets decreased from 1.29% in 2002 to 1.24% in 2003.
2002 COMPARED TO 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.
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-
13
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 AND EXPENSE
2003 COMPARED TO 2002
Net interest income for 2003 increased $721,000 or 5.0% to $15.1 million for the
year ended December 31, 2003 from $14.4 million for the year ended December 31,
2002. This increase resulted from an increase in total average earning assets
from $279.5 million in 2002 to $320.8 million in 2003, partially offset by a 44
basis point decrease in the net interest margin. The percentage of average
earning assets to total assets decreased in 2003 to 91.6% from 92.0% in 2002.
TFB's net interest margin decreased from 5.24% in 2002 to 4.80% in 2003.
Total interest income decreased $360,000 or 1.8% to $19.1 million in 2003 from
$19.5 million in 2002. This decrease was due to the decrease in yield on
interest-earning assets resulting from the declining market interest rates.
Average loan balances increased from $215.7 million in 2002 to $253.4 million in
2003. The average yield on loans decreased to 6.86% in 2003 compared with 8.05%
in 2002. Together, there was a $30,000 decrease in interest and fee income from
loans for the year 2003 compared with year 2002. Average investment security
balances increased $11.5 million from $51.1 million in 2002 to $62.7 million in
2003, primarily due to the excess liquidity generated from retail deposit growth
in 2002 and 2003. The tax-equivalent average yield on investments declined from
4.21% in 2002 to 3.12% in 2003. Together, there was a decrease in interest and
dividend income on security investments of $180,000 or 8.6%, from $2.1 million
in 2002 to $1.9 million in 2003. Average federal funds sold balances decreased
$8.0 million from $12.5 million in 2002 to $4.5 million in 2003. The average
yield on federal funds sold declined from 1.58% in 2002 to 1.08% in 2003.
Together, there was a $148,000 decrease in federal funds sold income from 2002
to 2003.
Total interest expense decreased $1.1 million or 21.3% from 2002 to 2003
primarily due to the decrease in cost on interest-bearing deposits also
resulting from the declining market interest rates. Average deposit balances
grew $38.7 million, primarily in demand deposits, time certificates of deposit,
and money market accounts. The average rate on interest-bearing liabilities
decreased from 2.25% in 2002 to 1.56% in 2003. The average rate on certificates
of deposit decreased from 3.81% in 2002 to 2.66% in 2003. Interest expense on
FHLB of Atlanta advances increased $15,000 from 2002 to 2003 due to the $1.1
million increase in average FHLB advances.
2002 COMPARED TO 2001
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
14
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 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.
The following table sets forth information relating to Bankshares' average
balance sheet and reflects the average yield on assets and average cost of
liabilities and the average yields and rates paid for each of the years ended
December 31, 2003, 2002 and 2001. The yields and costs are derived by dividing
income or expense by the average daily balances of assets and liabilities,
respectively, for the periods presented.
15
AVERAGE BALANCES, INCOME AND EXPENSES, AND AVERAGE YIELDS AND RATES
(In Thousands)
12 Months Ending December 31, 2003 12 Months Ending December 31, 2002
---------------------------------- ----------------------------------
Average Income/ Average Average Income/ Average
ASSETS: Balances Expense Rate Balances Expense Rate
-------- ------- ---- -------- ------- ----
Loans
Taxable $243,975 $16,722 6.85% $208,622 $16,863 8.08%
Tax-exempt (1) 8,494 676 7.96% 6,128 509 8.30%
Nonaccrual 962 0 993 0
-------- ------- -------- -------
Total Loans 253,431 17,398 6.86% 215,743 17,372 8.05%
-------- ------- -------- -------
Securities and interest-bearing deposits
Taxable 61,154 1,851 3.03% 48,768 1,990 4.08%
Tax-exempt (1) 1,503 101 6.75% 2,364 164 6.94%
-------- ------- -------- -------
Total securities 62,657 1,952 3.12% 51,132 2,154 4.21%
-------- ------- -------- -------
Deposits in banks 183 2 1.07% 174 3 1.72%
Federal funds sold 4,502 49 1.08% 12,489 197 1.58%
-------- ------- -------- -------
Total earning assets 320,773 19,401 6.05% 279,538 19,726 7.06%
-------- ------- -------- -------
Less: Reserve for loan losses (3,146) (2,957)
Cash and due from banks 16,092 16,563
Bank premises and equipment, net 7,491 6,532
Other assets 8,896 4,258
-------- --------
Total Assets $350,106 $303,934
======== ========
LIABILITIES AND
SHAREHOLDERS' EQUITY:
Deposits
Demand deposits $ 63,647 $ 51,016
Interest-bearing deposits
NOW accounts 53,296 124 0.23% 46,403 165 0.36%
Money market accounts 61,388 634 1.03% 53,348 932 1.75%
Savings accounts 40,429 196 0.48% 37,833 439 1.16%
Time deposits 78,701 2,093 2.66% 70,179 2,671 3.81%
-------- ------- -------- -------
Total interest-bearing deposits 233,814 3,047 1.30% 207,763 4,207 2.02%
-------- ------- -------- -------
Federal funds purchased 2,862 39 1.35% -- --
Federal Home Loan Bank advances 16,068 721 4.48% 15,000 705 4.70%
Capital Securities of Subsidiary Trust 4,000 195 4.87% 3,079 170 5.52%
-------- ------- -------- -------
Total interest-bearing liabilities 256,744 4,001 1.56% 225,842 5,082 2.25%
-------- ------- -------- -------
Other liabilities 2,346 2,112
Shareholders' equity 27,369 24,964
-------- --------
Total Liabilities & Shareholders' Equity $350,106 $303,934
======== ========
Net interest spread $15,400 4.49% $14,644 4.81%
======= =======
Interest expense as a percent of average earning assets 1.25% 1.82%
Net interest margin (2) 4.80% 5.24%
12 Months Ending December 31, 2001
----------------------------------
Average Income/ Average
ASSETS: Balances Expense Rate
-------- ------- ----
Loans $202,854 $17,330 8.54%
Taxable 4,969 436 8.77%
Tax-exempt (1) 980 0
Nonaccrual -------- -------
208,803 17,766 8.51%
Total Loans -------- -------
23,569 1,334 5.66%
Securities and interest-bearing deposits 3,288 235 7.13%
Taxable -------- -------
Tax-exempt (1) 26,857 1,569 5.84%
-------- -------
Total securities 91 3 3.16%
18,839 676 3.59%
Deposits in banks -------- -------
Federal funds sold 254,590 20,014 7.86%
-------- -------
Total earning assets
Less: Reserve for loan losses (2,778)
Cash and due from banks 11,917
Bank premises and equipment, net 5,621
Other assets 4,355
--------
Total Assets $273,705
========
LIABILITIES AND
SHAREHOLDERS' EQUITY:
Deposits $ 43,628
Demand deposits
Interest-bearing deposits
NOW accounts 39,980 262 0.66%
Money market accounts 36,307 1,049 2.89%
Savings accounts 32,137 695 2.16%
Time deposits 76,469 4,256 5.57%
-------- -------
Total interest-bearing deposits 184,893 6,262 3.39%
-------- -------
Deposits in banks
Federal funds purchased -- --
Federal Home Loan Bank advances 18,874 957 5.07%
Capital Securities of Subsidiary Trust -- --
-------- -------
Total interest-bearing liabilities 203,767 7,220 3.54%
-------- -------
Other liabilities 2,445
Shareholders' equity 23,865
--------
Total Liabilities & Shareholders' Equity $273,705
========
--------
Net interest spread $ 12,794 4.32%
========
Interest expense as a percent of average earning assets 2.84%
Net interest margin (2) 5.02%
(1) Income and rates on non-taxable assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
(2) Net interest spread divided by total earning assets.
16
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)
2003 Compared to 2002 2002 Compared to 2001
--------------------------------- ---------------------------------
Due to Due to Due to Due to
Change Volume Rate Change Volume Rate
------- ------- ------- ------- ------- ------
Loans; taxable $ (141) $ 2,858 $(2,999) $ (467) $ 493 $ (960)
Loans; tax-exempt (1) 168 196 (29) 73 102 (28)
Securities; taxable (139) 505 (645) 656 1,426 (771)
Securities; tax-exempt (1) (63) (60) (3) (71) (66) (5)
Deposits in banks (1) 0 (1) -- 3 (3)
Federal funds sold (148) (126) (22) (479) (228) (251)
------- ------- ------- ------- ------- -------
Total Interest Income (325) 3,374 (3,699) (288) 1,729 (2,017)
------- ------- ------- ------- ------- -------
INTEREST EXPENSE
NOW accounts (41) 25 (66) (97) 42 (139)
Money market accounts (298) 140 (438) (117) 492 (608)
Savings accounts (243) 30 (273) (256) 123 (378)
Time deposits (578) 324 (902) (1,585) (350) (1,235)
Federal funds purchased and securities
sold under agreements to repurchase 39 39 -- -- -- --
Federal Home Loan Bank advances 15 50 (35) (252) (196) (56)
Capital securities of subsidiary trust 25 51 (26) 170 170 --
------- ------- ------- ------- ------- -------
Total Interest Expense (1,081) 659 (1,740) (2,137) 281 (2,416)
------- ------- ------- ------- ------- -------
Net Interest Income $ 757 $ 2,715 $(1,958) $ 1,849 $ 1,448 $ 400
======= ======= ======= ======= ======= =======
(1) Income and rates on tax-exempt assets are computed on a tax equivalent
basis using a federal tax rate of 34%.
ALLOWANCE FOR LOAN LOSSES AND ASSET QUALITY
At December 31, 2003 and 2002, net loans accounted for 78.0% and 66.5%,
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 Statement 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
17
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 net realizable 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 judgment 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. As is the case for all loans,
charge-offs for impaired loans occur when the loan or portion of the loan is
determined to be uncollectible.
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, 2003, 2002, 2001, 2000, and 1999.
LOAN PORTFOLIO (In Thousands)
December 31,
------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Loans secured by real estate:
Construction $ 21,243 $ 10,685 $ 16,851 $ 12,948 $ 11,746
Secured by Farmland 1,329 2,416 2,220 381 903
1-4 Family Residential 119,116 76,646 72,692 74,167 64,921
Commercial Real Estate 81,884 62,030 62,845 53,959 50,988
Commercial and industrial loans
(except those secured by real estate) 21,070 20,386 15,154 17,148 16,689
Consumer loans to individuals (except those
secured by real estate) 41,429 35,397 34,640 36,083 33,787
All other loans 13,033 9,186 5,962 5,873 4,868
-------- -------- -------- -------- --------
Total loans 299,104 216,746 210,364 200,559 183,902
Less: Unearned discount 217 138 54 126 115
-------- -------- -------- -------- --------
Total loans, net of unearned discount $298,887 $216,608 $210,310 $200,433 $183,787
======== ======== ======== ======== ========
The following is a schedule of maturities and sensitivities of loans subject to
changes in interest rates as of December 31, 2003:
18
MATURITY SCHEDULE OF SELECTED LOANS
(In Thousands)
1 Year
Within Within After
1 Year 5 Years 5 Years Total
------- ------- ------- -------
Commercial and industrial loans $11,192 $ 8,948 $ 930 $21,070
Construction loans 17,706 2,824 714 21,243
------- ------- ------- -------
$28,898 $11,772 $ 1,643 $42,313
======= ======= ======= =======
For maturities over one year:
Floating rate loans $ 1,556 $ 568 $ 2,125
Fixed rate loans 10,216 1,075 $11,291
------- ------- -------
$11,772 $ 1,643 $13,415
======= ======= =======
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,
--------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Nonaccrual loans $967 $850 $913 $121 $125
Restructured loans -- -- -- -- --
Other real estate owned -- -- -- -- --
---- ---- ---- ---- ----
Total non-performing assets $967 $850 $913 $121 $125
==== ==== ==== ==== ====
Loans past due 90 days
accruing interest $840 $244 $541 $800 $170
==== ==== ==== ==== ====
Allowance for loan losses to
total loans at period end 1.20% 1.34% 1.36% 1.27% 1.24%
Non-performing assets to
period end loans and other
real estate owned 0.33% 0.39% 0.43% 0.06% 0.07%
Potential Problem Loans: At December 31, 2003, Management is not aware of any
significant problem loans not included in table.
19
The allowance for loan losses is maintained at a level which, in management's
judgment, 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, 2003, 2002, 2001, 2000, and 1999 the allowance for loan losses
was $3,575,000, $2,910,000, $2,857,000, $2,554,000, and $2,284,000,
respectively.
The following table summarizes TFB's loan loss experience for each of the last
five years ended December 31, 2003, 2002, 2001, 2000, and 1999, respectively:
20
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(In Thousands)
Year Ended December 31,
------------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Allowance for Loan Losses, January 1 $2,910 $2,857 $2,554 $2,284 $1,853
------ ------ ------ ------ ------
Loans Charged-Off:
Commercial and industrial 74 135 91 247 217
Real estate-construction -- -- -- 4 --
Real estate-commercial 19 65 -- -- --
Real estate-residential -- -- 100 20 --
Consumer 186 141 86 171 110
------ ------ ------ ------ ------
Total Loans Charged-Off $ 279 $ 341 $ 277 $ 442 $ 327
------ ------ ------ ------ ------
Recoveries:
Commercial and industrial 60 18 193 45 18
Real estate-construction -- -- -- -- --
Real estate-commercial 75 -- -- -- --
Real estate-residential -- 14 -- 177 4
Consumer 25 16 37 33 41
------ ------ ------ ------ ------
Total Recoveries $ 160 $ 48 $ 230 $ 255 $ 63
------ ------ ------ ------ ------
Net Charge-Offs $ 119 $ 293 $ 47 $ 187 $ 264
------ ------ ------ ------ ------
Provision for Loan Losses $ 784 $ 346 $ 350 $ 457 $ 695
------ ------ ------ ------ ------
Allowance for Loan Losses, December 31 $3,575 $2,910 $2,857 $2,554 $2,284
====== ====== ====== ====== ======
Ratio of Net Charge-Offs
to Average Loans: 0.04% 0.14% 0.02% 0.10% 0.15%
====== ====== ====== ====== ======
The following table allocates the allowance for loan losses at December 31,
2003, 2002, 2001, 2000, and 1999 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 2003, 2002, and 2001
may not be comparable to prior periods.
21
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
(In Thousands)
2003 2002 2001
------------------------ ----------------------- ------------------------
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 & industrial $1,701 7.04% $1,663 9.41% $1,982 7.21%
Real Estate:
Construction -- 7.10% -- 4.93% -- 8.01%
Secured by farmland -- 0.44% -- 1.12% -- 1.06%
1-4 Family residential 634 39.82% 262 35.36% 448 34.56%
Commercial real estate 439 27.38% 364 28.61% -- 29.88%
Consumer 801 13.85% 621 16.33% 427 16.45%
All other loans -- 4.36% -- 4.24% -- 2.83%
------ ------ ------ ------ ------ ------
$3,575 100.00% $2,910 100.00% $2,857 100.00%
====== ====== ====== ====== ====== ======
2000 1999
------------------------ ------------------------
Allowance Percentage Allowance Percentage
for Loan of Total for Loan of Total
Losses Loans Losses Loans
--------- ---------- --------- ----------
Commercial & industrial $ 950 8.55% $ 895 9.08%
Real Estate:
Construction 25 6.46% -- 6.39%
Secured by farmland -- 0.19% -- 0.49%
1-4 Family residential 300 36.98% 264 35.32%
Commercial real estate 50 26.90% -- 27.74%
Consumer 1,229 17.99% 1,125 18.38%
All other loans -- 2.93% -- 2.65%
------ ------ ------ ------
$2,554 100.00% $2,284 100.06%
====== ====== ====== ======
The provision for loan losses was $784,000 for 2003, $346,000 for 2002 and
$350,000 for 2001. The amount of the provision for loan loss for 2003, 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. The growth in the provision for loan losses from 2002 to 2003
primarily reflects the same year to year growth in smaller-balance, homogeneous
loans, including 1-4 family mortgage loans, installment loans, other consumer
loans, and outstanding loan commitments. 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.
22
NON-PERFORMING LOANS
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 borrowers that
have suffered financial distress, to determine if they should be placed on
non-accrual status. Factors considered by management include the net realizable
value of collateral, if any, and other resources of the borrower that may be
available to satisfy the delinquency.
Non-performing loans totaled $967,000 or 0.33% of total loans at December 31,
2003, as compared with $850,000, or 0.39% of total loans at December 31, 2002.
Non-performing loans as a percentage of the allowance for loan losses were 26.9%
and 29.2% at December 31, 2003 and 2002, respectively.
Loans that were 90 days past due and accruing interest totaled $840,000 and
$244,000 at December 31, 2003 and 2002, respectively. At December 31, 2003,
loans 90 days past due consisted of four loans. Of the $840,000, $811,000 was
secured by real estate. No material loss is anticipated on any of these four
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. At
December 31, 2003, no concentration of loans to commercial borrowers engaged in
similar activities exceeds 10% of total loans. The largest industry
concentration at December 31, 2003 was approximately 4.7% of loans to the
hospitality industry (hotels, motels, inns, etc.).
NON-INTEREST INCOME
2003 COMPARED TO 2002
Total non-interest income increased by $1.1 million from $3.9 million in 2002 to
$5.0 million in 2003. Non-interest income is derived primarily from fee income,
which consists primarily of fiduciary and other WMS fees, service charges on
deposit accounts, and other fee income. This increase stemmed primarily from the
net gain on sale of securities, as well as from revenues related to the
continued growth of TFB's deposit base and retail banking activities, the
increase of estate fees within TFB's WMS, and income generated from the purchase
of bank-owned life insurance ("BOLI"). WMS income increased $241,000 or 34.7%
from 2002 to 2003. Service charges on deposit accounts increased $342,000, or
16.0% to $2.5 million for 2003, compared with $2.1 million for 2002. The major
factor in the increase in service charges on deposit accounts was the impact of
TFB's average demand deposit base increasing 24.8% from $51.0 million during
2002 to $63.6 million during 2003. Other service charges, commissions and fees
increased 36.4% from $1.0 million in 2002 to $1.3 million primarily due to
$212,000 of income from the February 28, 2003 purchase of $5 million of BOLI
policies on certain key executives, as well as increased income from VISA check
card fees. Gains on securities, available for sale was $248,000 for 2003, the
result of selling $10 million of available-for-sale government agency and
corporate securities, whose weighted-average remaining maturity was
approximately one year, for a gain on sale of $288,000, and reinvesting the
proceeds from the sale into available-for-sale government agency securities with
a weighted-average remaining maturity of approximately four years. This was
partially offset by a loss on the sale of a $5 million investment in a
short-term mortgage-backed security bond mutual fund.
Management seeks to increase the level of its future fee income from wealth
management services and deposits through the increase of its market share within
its marketplace. Wealth management fees are not projected to continue to grow at
a 35% annual pace as it did in 2003, but are projected to stabilize during 2004
and show more moderate growth over the longer term. Fees from deposits are
projected to grow approximately in concert with the growth in demand deposit
balances, and as result, are expected to be somewhat less than 2003's annual
growth of 16%. Income from BOLI will be less in 2004 than 2003 due to the effect
of the decline in market interest rates over the last two years on the crediting
rate on the insurance. Management is not projecting any gains on the sale of
securities at this time.
23
2002 COMPARED TO 2001
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 non-interest
income increased by $607,000, or 18.4%. Non-interest income is derived primarily
from fee income, which consists primarily of fiduciary and other WMS 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 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
2003 COMPARED TO 2002
Total non-interest expense increased $925,000, or 7.5% in 2003 from 2002. The
primary component of this was an increase in salaries and employees' benefits of
$637,000, or 10.8%, primarily due to the increase in full-time equivalent
personnel from approximately 114 at year-end 2001 and 119 at year-end 2002 to
128 at year-end 2003, as well as customary annual salary increases. The growth
in personnel primarily reflects the expansion of the lending function.
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 2003. Occupancy expenses increased $106,000, or 14.5%, from
2002 to 2003 primarily due to rent and other leasehold expenses associated with
the full year effect of the 2002 addition of finance/accounting offices in
Alexandria Pike, Warrenton, as well as significant growth in snow removal
expense during early 2003. Furniture and equipment increased $127,000 or 12.1%,
which correspond with the growth in occupancy expenses.
TFB expects personnel costs, consisting primarily of salary and benefits, to
continue to be its largest non-interest expense. As such, the most important
factor with regard to potential changes in other expenses is the expansion of
staff. The cost of any additional staff expansion, however, would be expected to
be offset by the increased revenue generated by the additional services that the
new staff would enable TFB to perform. During 2004, TFB projects to expand its
personnel base primarily to staff its new branch in Bealeton, Virginia.
Similarly, occupancy, equipment, marketing, and other expenses will increase in
response to this new branch opening.
2002 COMPARED TO 2001
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 $80,000 for the year ended December 31, 2003
compared to the year ended December 31, 2002. The effective tax rates were 29.6%
for 2003 and 30.7% for 2002. 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, as well as TFB's BOLI purchase.
24
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.
FINANCIAL CONDITION
Total assets were $378.5 million at December 31, 2003, an increase of 17.7% or
$57.0 million from $321.5 million at December 31, 2002. Balance sheet categories
reflecting significant changes included cash and due from banks, investment
securities, total loans, bank premises and equipment, other assets, and
deposits. Each of these categories is discussed below.
CASH AND DUE FROM BANKS. Cash and due from banks was $11.8 million at December
31, 2003, reflecting a decrease of $8.0 million from December 31, 2002.
INVESTMENT SECURITIES. Total investment securities were $52.4 million at
December 31, 2003, reflecting a decrease of $19.4 million from $71.7 million at
December 31, 2002. The decrease was primarily the result of redeploying the
proceeds from the prepayment of mortgage-backed securities into loans. At
December 31, 2003 and 2002, all investment securities were available for sale.
The valuation allowance for the available for sale portfolio had an unrealized
gain, net of tax, of $13,000 at December 31, 2003 compared with an unrealized
gain, net of tax, of $670,000 at December 31, 2002.
At December 31, 2003, 2002 and 2001, the carrying values of the major
classifications of securities were as follows:
INVESTMENT PORTFOLIO
(In Thousands)
Available for Sale (1)
-------------------------------
2003 2002 2001
------- ------- -------
Obligations of U.S. Government
corporations and agencies $46,639 $58,957 $26,844
Obligations of states and
political subdivisions 1,236 1,721 3,103
Corporate Bonds 2,929 4,361 5,229
Mutual funds -- 5,067 --
Restricted investment - Federal
Home Loan Bank stock 1,000 1,029 1,150
FHLMC preferred stock 460 480 460
Other securities 122 122 122
------- ------- -------
Total $52,386 $71,737 $36,908
------- ------- -------
(1) Amounts for available-for-sale securities are based on fair value.
25
The following is a schedule of estimated maturities or next rate adjustment date
and related weighted average yields of securities at December 31, 2003:
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 $12,547 3.12% $16,491 3.20% $17,429 3.81%
Corporate bonds -- -- -- -- 2,929 4.40%
Other taxable securities -- -- -- -- -- --
------- ------- -------
Total taxable $12,547 3.12% $16,491 3.20% $20,358 3.89%
------- ------- -------
Obligations of states and political
subdivisions, tax-exempt 205 3.12% -- -- --
------- ------- -------
TOTAL SECURITIES: $12,752 3.12% $16,491 3.20% $20,358 3.89%
======= ======= =======
Due after 10 years
and Equity Securities Total
---------------------- ----------------
Amount Yield Amount Yield
------- ----- ------- -----
SECURITIES AVAILABLE FOR SALE:
Obligations of U.S. Government
corporations and agencies $ 172 6.49% $46,639 3.41%
Corporate bonds 2,929 4.40%
Other taxable securities 1,582 3.34% 1,582 3.34%
------- -------
Total taxable $ 1,754 3.65% $51,150 3.47%
------- -------
Obligations of states and political
subdivisions, tax-exempt 1,031 6.03% 1,236 5.55%
------- -------
TOTAL SECURITIES: $ 2,785 4.53% $52,386 3.52%
======= =======
Excluding obligations of U.S. Government corporations and agencies, no TFB
security investment exceeded 10% of stockholder equity.
LOANS. Total net loan balance after allowance for loan losses was $295.3 million
at December 31, 2003, which represents an increase of $81.6 million or 38.2%
from $213.7 million at December 31, 2002. The majority of the increase was in
1-4 family residential real estate loans, which increased $42.5 million from
year-end 2002 to year-end 2003, as well as commercial real estate and
construction loans, which increased $19.9 million and $10.6 million,
respectively, over the same time period. TFB's loans are made primarily to
customers located within TFB's primary market area. During 2003, TFB modified
its loan pricing strategies and expanded its loan product offerings in an effort
to increase lending activity without sacrificing the existing credit quality
standards. This was primary reason for the year to year increase in residential
and commercial real estate loans outstanding. Management will continue the same
pricing strategies during 2004, but does not project to originate the same level
of 1-4 family residential real estate loans as in 2003, primarily due to
competitive pressures and market interest rates.
BANK PREMISES AND EQUIPMENT, NET. Bank premises and equipment, net of
depreciation, increased $1.4 million from $6.5 million at December 31, 2002 to
$7.9 million at December 31, 2003. Approximately $1.2 million of the increase
was related to the purchase of land for a branch office in Bealeton, Virginia to
be opened in 2004.
26
OTHER ASSETS. Other assets increased $6.8 million from December 31, 2002 to
December 31, 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 December 31, 2003, the cash
surrender value of BOLI was $5,212,000.
DEPOSITS. For the year ended December 31, 2003, total deposits grew $47.5
million or 17.3% when compared with total deposits one year earlier.
Non-interest-bearing deposits increased by $13.0 million and interest-bearing
deposits increased by $34.5 million. The growth in TFB's deposits during 2003
were the result of many possible factors difficult to segregate and quantify,
and equally difficult to use as factors for future projections. One factor was
TFB gaining in-market customers who grew dissatisfied with the service and
pricing resulting from the consolidation of other local community banks into
larger, out-of-market financial institutions. Another factor may have been the
outflow of funds from equity and mutual fund investments into bank deposits. A
third factor may have been gaining deposits from new loan customers. TFB
projects to increase its deposits in 2004 and beyond through the expansion of
its branch network, as well as by offering value added demand deposit products,
and selective rate premiums on its interest-bearing 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,
----------------------------------------------------------
2003 2002 2001
---------------- ---------------- ----------------
Amount Rate Amount Rate Amount Rate
-------- ---- -------- ---- -------- ----
Noninterest-bearing $ 63,647 $ 51,016 $ 43,628
-------- -------- --------
Interest-bearing:
NOW accounts 53,296 0.23% 46,403 0.36% 39,980 0.66%
Money market accounts 61,388 1.03% 53,348 1.75% 36,307 2.89%
Regular savings accounts 40,429 0.48% 37,833 1.16% 32,137 2.16%
Time deposits: 78,701 2.66% 70,179 3.81% 76,469 5.57%
-------- -------- --------
Total interest-bearing 233,814 1.30% 207,763 2.02% 184,893 3.39%
-------- -------- --------
Total deposits $297,461 $258,779 $228,521
======== ======== ========
The following is a schedule of maturities of time deposits in amounts of
$100,000 or more as of December 31, 2003:
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, 2003 $5,556 $7,489 $6,851 $7,003 $3,232 $30,130
====== ====== ====== ====== ====== =======
27
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.
BORROWINGS
Amounts and weighted average rates for long and short term borrowings for 2003,
2002 and 2001 are as follows:
BORROWED FUNDS
(In Thousands)
-------------------------------------------------------
December 31, 2003 December 31, 2002 December 31, 2001
----------------- ----------------- -----------------
Amount Rate Amount Rate Amount Rate
----------------- ----------------- -----------------
FHLB Advances $20,000 3.81% $15,000 4.64% $15,000 4.64%
Federal funds purchased 2,000 1.25% -- --
CONTRACTUAL OBLIGATIONS
The following table sets forth information relating to Bankshares' contractual
obligations and scheduled payment amounts due at various intervals over the next
five years and beyond.
(In Thousands) Payments due period
--------------------------------------------------------
Contractual Obligations: Less than More than
Total One Year 1-3 Years 3-5 Years 5 Years
--------------------------------------------------------
Long-term debt obligations $ 24,000 $ 5,000 $ 10,000 $ 5,000 $ 4,000*
Capital lease obligations -- -- -- -- --
Operating lease obligations 709 125 259 221 104
Purchase obligations -- -- -- -- --
Other long-term liabilities
reflected on
balance sheet -- -- -- -- --
--------------------------------------------------------
Total $ 24,709 $ 5,125 $ 10,259 $ 5,221 $ 4,104
========================================================
* Has varying put provisions beginning March 27, 2007 with a mandatory
redemption on March 26, 2032.
28
OFF-BALANCE SHEET ARRANGEMENTS
TFB's off-balance sheet arrangements consist of commitments to extend credit and
standby letters of credit, which were $70.2 million and $6.2 million,
respectively at December 31, 2003, and $42.1 million and $5.0 million,
respectively, at December 31, 2002. See Note 15 "Financial Instruments with
Off-Balance-Sheet Risk" to the 2003 Consolidated Financial Statements for
further discussion on the specific arrangements and elements of credit and
interest rate risk inherent to the arrangements. The impact on liquidity of
these arrangements is illustrated in the LIQUIDITY SOURCES AND USES table in
Item 7 under the title "Liquidity."
Revenues for standby letters of credit were $55,000 for the year ended December
31, 2003. At December 31, 2003 there were 73 separate standby letters of credit.
During 2003, only one liability, totaling $75,000, arose from the standby
letters of credit arrangements. This liability was offset by an insurance bond
payable to TFB. Past history gives little indication as to future trends
regarding revenues and liabilities from the standby letters of credit.
CAPITAL RESOURCES
Shareholders' equity totaled $28.5 million at December 31, 2003 compared with
$26.4 million at December 31, 2002. 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 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; 77,394 shares at a cost of $1.1
million in 2002; and 21,010 shares at a cost of $354,000 in 2003.
The securities portfolio valuation account decreased in its unrealized gain
after tax to $13,000 at December 31, 2003 compared from an unrealized gain of
$670,000 at December 31, 2002.
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. Under
these guidelines, the $4.0 million of capital securities issued by Bankshares'
subsidiary trust 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. Bankshares and TFB exceeded their
regulatory capital ratios, as set forth in the following table:
29
RISK BASED CAPITAL RATIOS
(in Thousands)
December 31,
-------------------------
2003 2002
-------- --------
Tier 1 Capital:
Shareholders' Equity $ 28,463 $ 26,431
Less: Unrealized gain on securities
available for sale (41) (670)
Less: Intangible assets, net (83) (109)
Plus: Company-obligated mandatorily
redeemable capital securities 4,000 4,000
-------- --------
Total Tier 1 Capital 32,339 29,652
Tier 2 Capital:
Allowable Allowance for Loan Losses 3,511 2,602
Total Capital: 35,850 32,254
-------- --------
Risk Weighted Assets: $280,916 $207,875
======== ========
Risk Based Capital Ratios:
Tier 1 to Risk Weighted Assets 11.51% 14.26%
Total Capital to Risk Weighted Assets 12.76% 15.52%
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.
LIQUIDITY
Cash and amounts due from depository institutions, interest-bearing deposits in
other banks, and federal funds sold totaled $12.0 million at December 31, 2003
compared with $24.9 million at December 31, 2002. These assets provide the
primary source of liquidity for TFB. In addition, management has designated the
entire investment portfolio as available of sale, of which approximately $40.7
million is unpledged and readily salable. Futhermore, TFB has an available line
of credit with the FHLB of Atlanta with a borrowing limit of approximately $60.4
million at December 31, 2003 to provide additional sources of liquidity, as well
as available federal funds purchased lines of credit with various commercial
banks totaling approximately $33.1 million. At December 31, 2003, $20.0 million
of the FHLB of Atlanta line of credit, and $2.0 million of commercial bank
federal funds purchased were in use.
The following table sets forth information relating to Bankshares' sources of
liquidity and the outstanding commitments for use of liquidity at December 31,
2003. The liquidity coverage ratio is derived by dividing the total sources of
liquidity by the outstanding commitments for use of liquidity.
30
LIQUIDITY SOURCES AND USES
(In Thousands)
December 31, 2003 December 31, 2002
------------------------------- -------------------------------
Total In Use Available Total In Use Available
-------- -------- --------- -------- -------- ---------
Sources:
Federal funds borrowing lines of credit $ 33,077 $ 2,000 $ 31,077 $ 33,077 $ -- $ 33,077
Federal Home Loan Bank advances 60,540 20,000 40,540 51,422 15,000 36,422
Federal funds sold 703 4,900
Securities, available for sale and unpledged
at fair value 40,655 63,077
-------- --------
Total short-term funding sources 112,975 137,476
======== ========
Uses:
Unfunded loan commitments and
lending lines of credit 70,158 42,101
Letters of credit 6,192 5,010
-------- --------
Total potential short-term funding uses 76,350 47,111
======== ========
Ratio of short-term funding sources to
potential short-term funding uses 148.0% 291.8%
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 and investment repayments, and securities
available for sale. TFB's primary external source of liquidity is advances from
the FHLB of Atlanta.
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
31
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 2003.
32
The following tables present TFB's market value changes in equity under various
rate scenarios as of December 31, 2003 and 2002.
MARKET RISK
- ------------------------------------------------------------------------------------------------------------------------
2003 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% $ -- $ -- $ -- $ -- $ -- 0.00%
Securities and interest-
bearing deposits 1.97% 1,035 53,563 52,528 49,587 (2,941) -5.60%
Loans receivable 2.23% 6,530 300,000 293,470 282,091 (11,379) -3.88%
--------- --------- --------- --------- ---------
Total rate sensitive assets 2.19% 7,565 353,563 345,998 331,678 (14,320) -4.14%
Other assets 0.00% -- 30,620 30,620 30,620 -- 0.00%
--------- --------- --------- --------- ---------
Total assets 2.01% $ 7,565 $ 384,183 $ 376,618 $ 362,298 $ (14,320) -3.80%
========= ========= ========= ========= =========
Demand Deposits 18.61% $ 11,029 $ 70,294 $ 59,265 $ 50,074 $ (9,191) -15.51%
Rate-bearing deposits 8.76% 18,597 230,996 212,399 199,222 (13,177) -6.20%
Borrowed funds 6.42% 1,633 27,069 25,436 25,001 (435) -1.71%
Other liabilities 0.00% -- 2,869 2,869 2,869 -- 0.00%
--------- --------- --------- --------- ---------
Total liabilities 10.42% 31,259 331,228 299,969 277,166 (22,803) -7.60%
Present Value Equity -30.91% (23,694) 52,956 76,650 85,133 8,483 11.07%
--------- --------- --------- --------- ---------
Total liabilities and equity 2.01% $ 7,565 $ 384,183 $ 376,618 $ 362,298 $ (14,320) -3.80%
========= ========= ========= ========= =========
- ------------------------------------------------------------------------------------------------------------------------
2002 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% $ -- $ 4,900 $ 4,900 $ 4,900 $ -- 0.00%
Securities and interest-
bearing deposits 5.87% 4,226 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%
========= ========= ========= ========= =========
33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
WARRENTON, VIRGINIA
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2003
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT ON THE
CONSOLIDATED FINANCIAL STATEMENTS 1
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets 2
Consolidated statements of income 3
Consolidated statements of cash flows 4 and 5
Consolidated statements of changes
in shareholders' equity 6
Notes to consolidated financial statements 7-36
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, 2003 and 2002, and
the related consolidated statements of income, changes in shareholders' equity
and cash flows for the years ended December 31, 2003, 2002 and 2001. 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, 2003 and 2002, and
the results of their operations and their cash flows for the years ended
December 31, 2003, 2002 and 2001, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 23, 2004
1
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
DECEMBER 31,
------------------------------
ASSETS 2003 2002
------------ ------------
Cash and due from banks $ 11,808,387 $ 19,824,120
Interest-bearing deposits in other banks 142,042 212,960
Federal funds sold -- 4,900,000
Securities, fair value 52,386,006 71,736,633
Loans, net of allowance for loan losses of $3,575,002 in 2003
and $2,909,607 in 2002 295,311,745 213,697,948
Bank premises and equipment, net 7,875,424 6,468,205
Accrued interest receivable 1,233,004 1,739,638
Other assets 9,703,670 2,919,978
------------ ------------
Total assets $378,460,278 $321,499,482
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing $ 73,128,879 $ 60,181,808
Interest-bearing 247,999,697 213,486,663
------------ ------------
Total deposits 321,128,576 273,668,471
Federal funds purchased 2,000,000 --
Federal Home Loan Bank advances 20,000,000 15,000,000
Company-obligated mandatorily redeemable capital securities 4,000,000 4,000,000
Dividends payable 430,590 363,447
Other liabilities 2,438,327 2,036,399
Commitments and contingent liabilities -- --
------------ ------------
Total liabilities 349,997,493 295,068,317
------------ ------------
SHAREHOLDERS' EQUITY
Common stock, par value, $3.13 per share; 8,000,000 shares authorized;
issued and outstanding, 2003, 3,312,230 shares; 2002, 3,304,066 shares 10,367,280 10,341,726
Retained earnings 18,082,684 15,419,307
Accumulated other comprehensive income 12,821 670,132
------------ ------------
Total shareholders' equity 28,462,785 26,431,165
------------ ------------
Total liabilities and shareholders' equity $378,460,278 $321,499,482
============ ============
See Notes to Consolidated Financial Statements.
2
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For Each of the Three Years in the Period Ended December 31, 2003
2003 2002 2001
----------- ----------- -----------
INTEREST AND DIVIDEND INCOME
Interest and fees on loans $17,168,004 $17,198,498 $17,617,424
Interest and dividends on securities available for sale:
Taxable interest income 1,576,813 1,795,511 1,174,762
Interest income exempt from federal income taxes 66,917 108,218 154,816
Dividends 274,097 194,587 159,089
Interest on federal funds sold 48,533 196,643 675,574
Interest on deposits in other banks 1,950 2,571 2,864
----------- ----------- -----------
Total interest and dividend income 19,136,314 19,496,028 19,784,529
----------- ----------- -----------
INTEREST EXPENSE
Interest on deposits 3,047,245 4,206,623 6,263,296
Interest on federal funds purchased 38,524 -- --
Distribution on capital securities of subsidiary trust 194,897 170,379 --
Interest on Federal Home Loan Bank advances 720,560 705,160 957,414
----------- ----------- -----------
Total interest expense 4,001,226 5,082,162 7,220,710
----------- ----------- -----------
Net interest income 15,135,088 14,413,866 12,563,819
Provision for loan losses 784,000 346,250 350,000
----------- ----------- -----------
Net interest income after provision for loan losses 14,351,088 14,067,616 12,213,819
----------- ----------- -----------
NONINTEREST INCOME
Wealth management income 935,534 694,442 704,681
Service charges on deposit accounts 2,473,161 2,131,445 1,711,222
Other service charges, commissions and fees 1,334,490 978,626 824,783
Non-loan charge-off recovery -- -- 542,320
Gain on securities available for sale 248,240 33,914 --
Other operating income 36,608 62,042 53,090
----------- ----------- -----------
Total noninterest income 5,028,033 3,900,469 3,836,096
----------- ----------- -----------
NONINTEREST EXPENSES
Salaries and employees' benefits 6,521,456 5,884,134 4,851,413
Net occupancy expense of premises 837,734 731,333 591,730
Furniture and equipment 1,176,014 1,049,280 861,427
FHLB prepayment penalty -- -- 572,600
Other operating expenses 4,686,758 4,631,779 4,060,530
----------- ----------- -----------
Total noninterest expenses 13,221,962 12,296,526 10,937,700
----------- ----------- -----------
Income before income taxes 6,157,159 5,671,559 5,112,215
Income tax expense 1,821,309 1,741,743 1,596,781
----------- ----------- -----------
Net income $ 4,335,850 $ 3,929,816 $ 3,515,434
=========== =========== ===========
EARNINGS PER SHARE, BASIC $ 1.31 $ 1.18 $ 1.03
=========== =========== ===========
EARNINGS PER SHARE, ASSUMING DILUTION $ 1.24 $ 1.14 $ 1.01
=========== =========== ===========
See Notes to Consolidated Financial Statements.
3
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For Each of the Three Years in the Period Ended December 31, 2003
2003 2002 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,335,850 $ 3,929,816 $ 3,515,434
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 1,047,748 941,787 747,886
Provision for loan losses 784,000 346,250 350,000
Deferred tax (benefit) (289,490) (123,229) (77,080)
(Gain) on securities available for sale (248,240) (33,914) --
(Gain) on sale of premises and equipment (2,645) (7,006) (65)
Tax benefit of nonqualified options exercised (64,307) (17,114) --
Amortization of security premiums, net 780,614 487,583 93,021
Changes in assets and liabilities:
(Increase) in other assets (584,646) (423,816) (223,769)
Increase (decrease) in other liabilities 401,928 57,189 (62,348)
------------ ------------ ------------
Net cash provided by operating activities 6,160,812 5,157,546 4,343,079
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available for sale 15,441,768 1,033,650 --
Proceeds from maturities, calls and principal
payments of securities available for sale 38,898,025 22,614,625 11,960,187
Purchase of securities available for sale (36,517,466) (53,193,487) (31,531,332)
Proceeds from sale of premises and equipment 2,645 7,006 65
Purchase of premises and equipment (2,454,967) (1,074,284) (1,826,406)
Purchase of other investment -- (5,066,023) --
Purchase of Bank Owned Life Insurance (5,000,000) -- --
Net (increase) in loans (82,397,797) (6,591,460) (9,923,858)
------------ ------------ ------------
Net cash (used in) investing activities (72,027,792) (42,269,973) (31,321,344)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW accounts
and saving accounts 38,702,951 28,437,904 36,585,184
Net increase (decrease) in certificates of deposit 8,757,154 1,483,525 (4,941,401)
Proceeds from issuance of capital securities -- 4,000,000 --
Federal Home Loan Bank advances 5,000,000 -- 10,000,000
Federal Home Loan Bank principal repayments -- -- (8,000,000)
Purchase of federal funds 2,000,000 -- --
Cash dividends paid (1,520,987) (1,310,949) (1,194,739)
Issuance of common stock 295,697 307,520 28,309
Acquisition of common stock (354,486) (1,050,524) (895,941)
------------ ------------ ------------
Net cash provided by financing activities 52,880,329 31,867,476 31,581,412
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents (12,986,651) (5,244,951) 4,603,147
CASH AND CASH EQUIVALENTS
Beginning 24,937,080 30,182,031 25,578,884
------------ ------------ ------------
Ending $ 11,950,429 $ 24,937,080 $ 30,182,031
============ ============ ============
See Notes to Consolidated Financial Statements.
4
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
For Each of the Three Years in the Period Ended December 31, 2003
2003 2002 2001
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest $ 4,026,887 $ 5,220,287 $ 7,371,938
=========== =========== ===========
Income taxes $ 1,944,000 $ 1,709,500 $ 1,872,500
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES
Unrealized gain (loss) on securities available for sale, net $ (995,926) $ 671,203 $ 473,759
=========== =========== ===========
Transfer of securities from held to maturity to available for sale $ -- $ -- $ 3,980,765
=========== =========== ===========
See Notes to Consolidated Financial Statements.
5
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For Each of the Three Years in the Period Ended December 31, 2003
ACCUMULATED
OTHER
COMPRE- COMPRE-
COMMON RETAINED HENSIVE HENSIVE
STOCK EARNINGS INCOME (LOSS) INCOME TOTAL
------------ ------------ ------------- ------------ ------------
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
Comprehensive income:
Net income -- 4,335,850 -- $ 4,335,850 4,335,850
Other comprehensive income net of tax:
Unrealized holding losses on securities
available for sale, net of deferred income
taxes of $254,213 -- -- -- (493,473) --
Less reclassification adjustment, net of
income tax expense of $84,402 -- -- -- (163,838) --
------------
Other comprehensive loss, net of tax: -- -- (657,311) (657,311) (657,311)
------------
Total comprehensive income $ 3,678,539 --
============
Cash dividends -- (1,588,130) -- (1,588,130)
Acquisition of 21,010 shares of
common stock (65,761) (288,725) -- (354,486)
Exercise of stock options 91,315 204,382 -- 295,697
------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 $ 10,367,280 $ 18,082,684 $ 12,821 $ 28,462,785
============ ============ ============ ============
See Notes to Consolidated Financial Statements.
6
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For Each of the Three Years in the Period Ended December 31, 2003
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 subsidiary, The
Fauquier Bank (the Bank), of which Fauquier Bank Services, Inc. is
its sole subsidiary. 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.
The Bank is required to maintain an investment in the capital
stock of certain correspondent banks. No readily available market
exists for this stock and it has no quoted market value. The
investment in these securities is recorded at cost.
LOANS
The Corporation 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.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 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.
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.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 ranging from 3 - 39
years; leasehold improvements are amortized over the lives of the
respective leases or the estimated useful life of the leasehold
improvement, whichever is less. Software is amortized over its
estimated useful life ranging from 3 - 5 years. 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 funds pension costs in accordance
with the funding provisions of the Employee Retirement Income
Security Act.
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, 2003, the Corporation has a stock-based
compensation plan. 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 if the
Corporation had applied the fair value recognition provisions of
FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based compensation.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31,
--------------------------------------------
2003 2002 2001
---------- ---------- ----------
Net income , as reported $4,335,850 $3,929,816 $3,515,434
Deduct: total stock-based employee compensation
expense determined based on the fair value
method of awards, net of tax (139,702) (296,042) (238,520)
---------- ---------- ----------
Pro forma net income $4,196,148 $3,633,774 $3,276,914
========== ========== ==========
Earnings per share:
Basic - as reported $ 1.31 $ 1.18 $ 1.03
========== ========== ==========
Basic - pro forma $ 1.26 $ 1.10 $ 0.96
========== ========== ==========
Diluted - as reported $ 1.24 $ 1.14 $ 1.01
========== ========== ==========
Diluted - pro forma $ 1.20 $ 1.05 $ 0.94
========== ========== ==========
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.
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.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ADVERTISING
The Corporation follows the policy of charging the costs of
advertising to expense as incurred. Advertising expenses of
$183,304, $356,830 and $262,886 were incurred in 2003, 2002 and
2001, respectively.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period balances
to conform to the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," which amends SFAS No. 123 to provide
alternative methods of transition for an entity that voluntarily
changes to the fair value based method of accounting for
stock-based employee compensation. The provisions of the Statement
were effective December 31, 2002. Management currently intends to
continue to account for stock-based compensation under the
intrinsic value method set forth in Accounting Principles Board
("APB") Opinion 25 and related interpretations. For this reason,
the transition guidance of SFAS No. 148 does not have an impact on
the Corporation's consolidated financial position or consolidated
results of operations. The Statement does amend existing guidance
with respect to required disclosures, regardless of the method of
accounting used. The revised disclosure requirements are presented
herein.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45"). The Interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements
under certain guarantees that it has issued. It also clarifies
that a guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. The recognition requirements
of the Interpretation were effective beginning January 1, 2003.
The initial adoption of the Interpretation did not materially
affect the Corporation, and management does not anticipate that
the recognition requirements of this Interpretation will have a
materially adverse impact on either the Corporation's consolidated
financial position or consolidated results of operations in the
future.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). This
Interpretation provides guidance with respect to the
identification of variable interest entities and when the assets,
liabilities, noncontrolling interests, and results of operations
of a variable interest entity need to be included in a
corporation's consolidated financial statements. The
Interpretation requires consolidation by business enterprises of
variable interest entities in cases where (a) the equity
investment at risk is not sufficient to permit the entity to
finance its activities without additional subordinated financial
support from other parties, which is provided through other
interests that will absorb some or all of the expected losses of
the entity, or (b) in cases where the equity investors lack one or
more of the essential characteristics of a controlling financial
interest, which include the ability to make decisions about the
entity's activities through
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
voting rights, the obligations to absorb the expected losses of
the entity if they occur, or the right to receive the expected
residual returns of the entity if they occur. Management has
evaluated the Corporation's investments in variable interest
entities and potential variable interest entities or transactions,
particularly in limited liability partnerships involved in
low-income housing development and trust preferred securities
structures. The implementation of FIN 46 did not have a
significant impact on either the Corporation's consolidated
financial position or consolidated results of operations.
Interpretive guidance relating to FIN 46 is continuing to evolve
and the Corporation's management will continue to assess various
aspects of consolidations and variable interest entity accounting
as additional guidance becomes available.
In April 2003, the FASB issued SFAS No. 149, "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities."
The Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities." The Statement is effective for contracts
entered into or modified after June 30, 2003, with certain
exceptions, and for hedging relationships designated after June
30, 2003 and is not expected to have an impact on the
Corporation's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity." This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that
an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of these
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 the
Corporation's consolidated financial statements.
In November 2003, the FASB's Emerging Issues Task Force (EITF)
reached a consensus on a new disclosure requirement related to
unrealized losses on investment securities. The new disclosure
requires a table of securities which have unrealized losses as of
the reporting date. The table must distinguish between those
securities which have been in a continuous unrealized loss
position for twelve months or more and those securities which have
been in a continuous unrealized loss position for less than twelve
months. The table is to include the aggregate unrealized losses of
securities whose fair values are below book values as of the
reporting date, and the aggregate fair value of securities whose
fair values are below book values as of the reporting date. In
addition to the quantitative disclosure, FASB requires a narrative
discussion that provides sufficient information to allow financial
statement users to understand the quantitative disclosures and the
information that was considered in determining whether impairment
was not other-than-temporary. The new disclosure requirements
apply to fiscal years ending after December 15, 2003. The
Corporation has included the required disclosures in their
consolidated financial statements.
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2003, the FASB issued a revised version of SFAS No.
132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits an amendment of FASB Statements No. 87, 88
and 106." This Statement revises employers' disclosures about
pension plans and other postretirement benefits. It does not
change the measurement or recognition of those plans required by
FASB Statements No. 87, No. 88, and No. 106. This Statement
retains the disclosure requirements contained in the original FASB
Statement No. 132, which it replaces. However, it requires
additional disclosures to those in the original Statement 132
about the assets, obligations, cash flows, and net periodic
benefit costs of defined benefit pension plans and other defined
benefit postretirement plans. The required information should be
provided separately for pension plans and for other postretirement
benefit plans. The disclosures for earlier annual periods
presented for comparative purposes are required to be restated for
(a) the percentages of each major category of plan assets held,
(b) the accumulated benefit obligation, and (c) the assumptions
used in the accounting for the plans. This Statement is effective
for financial statements with fiscal years ending after December
15, 2003. The interim-period disclosures required by this
Statement are effective for interim periods beginning after
December 15, 2003. The Corporation has included the required
disclosures in its consolidated financial statements.
NOTE 2. SECURITIES
The amortized cost of securities available for sale, with unrealized
gains and losses follows:
DECEMBER 31, 2003
--------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS (LOSSES) VALUE
------------ ------------ ------------ ------------
Obligations of U.S.
Government corporations
and agencies $ 46,592,397 $ 254,827 $ (208,599) $ 46,638,625
Obligations of states and
political subdivisions 1,164,580 72,001 -- 1,236,581
Corporate bonds 3,000,000 -- (71,200) 2,928,800
Restricted investments:
Federal Home Loan
Bank stock 1,000,000 -- -- 1,000,000
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
------------ ------------ ------------ ------------
$ 52,366,477 $ 326,828 $ (307,299) $ 52,386,006
============ ============ ============ ============
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
============ ============ ============ ============
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.
2003
----------------------------
AMORTIZED FAIR
COST VALUE
----------- -----------
Due in one year or less $ 203,606 $ 204,857
Due after one year through five years 17,235,320 17,212,202
Due after five years through ten years 4,331,907 4,326,217
Due after ten years 28,986,144 29,060,730
Equity securities 1,609,500 1,582,000
----------- -----------
$52,366,477 $52,386,006
=========== ===========
For the years ended December 31, 2003 and 2002, proceeds from sales of
securities available for sale amounted to $15,441,768 and $1,033,650,
respectively. Gross realized gains amounted to $288,333 and $33,914.
Gross realized losses were $40,093 in 2003, and there were no gross
realized losses in 2002. The tax expense applicable to this net
realized gain amounted to $84,402 and $11,531. There were no sales of
securities available for sale for the year ended December 31, 2001.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table shows the Corporation investments' gross unrealized
losses and fair value, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized
loss position, at December 31, 2003.
LESS THAN 12 MONTHS 12 MONTHS OR MORE TOTAL
------------------------ ------------------------ ------------------------
UNREALIZED UNREALIZED UNREALIZED
DESCRIPTION OF SECURITIES FAIR VALUE (LOSSES) FAIR VALUE (LOSSES) FAIR VALUE (LOSSES)
- ------------------------------ ----------- ----------- ----------- ----------- ----------- -----------
Obligations of U.S. government
corporations and agencies $22,829,608 $ (208,599) $ -- $ -- $22,829,608 $ (208,599)
Corporate bonds 2,928,800 (71,200) -- -- 2,928,800 (71,200)
Subtotal, debt securities 25,758,408 (279,799) -- -- 25,758,408 (279,799)
Preferred stock 487,500 (27,500) -- -- 487,500 (27,500)
----------- ----------- ----------- ----------- ----------- -----------
Total temporarily
impaired securities $26,245,908 $ (307,299) $ -- $ -- $26,245,908 $ (307,299)
=========== =========== =========== =========== =========== ===========
The nature of the securities which are temporarily impaired can be
segmented into three groups. The first group consists of four Federal
Home Loan Bank securities totaling $10.9 million with a temporary loss
of $75,000. Within this group, one bond totaling $2.0 million has a
remaining maturity of approximately 36 months, and the remaining three
bonds totaling $8.9 million have remaining maturities of approximately
66 months. All bonds within this group have Aaa/AAA ratings from
Moody's and Standard & Poors. The Corporation has the ability to hold
these bonds to their maturity.
The second group consists of six Federal agency mortgage-backed
securities totaling $11.9 million with a temporary loss of $133,599.
The securities within this group have estimated maturity dates ranging
from four months to 37 months, and return principal on a monthly basis
representing the repayment and prepayment of the underlying mortgages.
The Corporation has the ability to hold these bonds to their maturity.
The third group consists of two corporate bonds, both rated A2 by
Moody's, totaling $2.9 million with a temporary loss of $71,200. Both
bonds have remaining maturities of approximately 29 years, but can be
called at par at their respective five year anniversary. If not called,
both bonds reprice every three months at a fixed index above LIBOR. The
Corporation has the ability to hold these bonds to their maturity.
The final security is preferred stock with Freddie Mac totaling
$487,500 with a temporary loss of $27,500. The Corporation has the
ability to hold this stock.
The carrying value of securities pledged to secure deposits and for
other purposes amounted to $10,635,147 and $7,023,657 at December 31,
2003 and 2002, respectively.
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. LOANS
A summary of the balances of loans follows:
DECEMBER 31,
----------------------
2003 2002
-------- --------
(Dollars in Thousands)
Mortgage loans on real estate:
Construction $ 21,243 $ 10,685
Secured by farmland 1,329 2,416
Secured by 1 to 4 family residential 119,116 76,646
Other real estate loans 81,884 62,030
Commercial and industrial loans (except
those secured by real estate) 21,070 20,386
Consumer installment loans 41,429 35,397
All other loans 13,033 9,186
-------- --------
Total loans 299,104 216,746
Less: Unearned income 217 138
Allowance for loan losses 3,575 2,910
-------- --------
Net loans $295,312 $213,698
======== ========
NOTE 4. ALLOWANCE FOR LOAN LOSSES
Analysis of the allowance for loan losses follows:
2003 2002 2001
----------- ----------- -----------
Balance at beginning of year $ 2,909,607 $ 2,856,743 $ 2,554,033
Provision charged to operating expense 784,000 346,250 350,000
Recoveries added to the allowance 160,089 47,918 230,310
Loan losses charged to the allowance (278,694) (341,304) (277,600)
----------- ----------- -----------
Balance at end of year $ 3,575,002 $ 2,909,607 $ 2,856,743
=========== =========== ===========
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information about impaired loans is as follows:
2003 2002
-------- --------
Impaired loans for which an allowance
has been provided $685,712 $686,113
Impaired loans for which no allowance
has been provided 23,438 --
-------- --------
Total impaired loans $709,150 $686,113
======== ========
Allowance provided for impaired loans,
included in the allowance for loan losses $ 50,000 $102,000
======== ========
2003 2002 2001
-------- -------- --------
Average balance in impaired loans $749,583 $855,926 $843,586
======== ======== ========
Interest income recognized $ -- $ -- $ --
======== ======== ========
No additional funds are committed to be advanced in connection with
impaired loans.
Nonaccrual loans excluded from the above impaired loan disclosure under
FASB 114 amounted to $258,373, $163,406 and $136,134 at December 31,
2003, 2002 and 2001, respectively. If interest on these loans had been
accrued, such income would have approximated $7,128, $6,938 and $4,066
for 2003, 2002 and 2001, 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 $5,227,922 at December 31, 2003 and $2,217,571 at December
31, 2002. During 2003, total principal additions were $5,254,338 and
total principal payments were $2,243,987.
17
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:
2003 2002
----------- -----------
Land $ 2,104,960 $ 864,667
Buildings and improvements 6,563,299 6,397,628
Furniture and equipment 8,545,969 8,037,305
Leasehold improvements 287,463 281,363
Construction in progress 327,556 101,940
----------- -----------
17,829,247 15,682,903
Less accumulated depreciation and amortization 9,953,823 9,214,698
----------- -----------
$ 7,875,424 $ 6,468,205
=========== ===========
Depreciation and amortization charged to operations totaled $1,047,748,
$941,787 and $747,886 in 2003, 2002 and 2001, respectively.
NOTE 7. DEPOSITS
The aggregate amount of time deposits, in denominations of $100,000 or
more at December 31, 2003 and 2002 was $30,129,576 and $23,025,164,
respectively.
At December 31, 2003, the scheduled maturities of time deposits are as
follows:
2004 $45,614,391
2005 17,928,297
2006 2,769,324
2007 3,870,847
2008 9,054,052
-----------
$79,236,911
===========
Overdraft demand deposits totaling $3,954,518 and $1,574,580 were
reclassified to loans at December 31, 2003 and 2002, respectively.
18
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, 2003, computed as of October 1st
of each respective year:
2003 2002 2001
----------- ----------- -----------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning $ 5,177,305 $ 4,036,939 $ 3,736,910
Service cost 371,747 270,440 215,762
Interest cost 360,435 300,755 278,253
Actuarial (gain) loss 481,228 714,662 (115,194)
Benefits paid (115,695) (145,491) (78,792)
----------- ----------- -----------
Benefit obligation, ending $ 6,275,020 $ 5,177,305 $ 4,036,939
----------- ----------- -----------
CHANGE IN PLAN ASSETS
Fair value of plan assets, beginning $ 3,684,823 $ 3,774,469 $ 4,470,263
Actual return on plan assets 887,791 (379,381) (914,910)
Employer contributions 402,810 435,226 297,908
Benefits paid (115,695) (145,491) (78,792)
----------- ----------- -----------
Fair value of plan assets, ending $ 4,859,729 $ 3,684,823 $ 3,774,469
----------- ----------- -----------
FUNDED STATUS $(1,417,481) $(1,492,482) $ (262,470)
Unrecognized net actuarial loss 1,335,922 1,483,542 65,173
Unrecognized net obligation at transition (151,824) (170,803) (189,782)
Unrecognized prior service cost 62,137 69,903 77,669
----------- ----------- -----------
Accrued benefit cost included in other liabilities $ (171,246) $ (109,840) $ (309,410)
----------- ----------- -----------
The following table provides the components of net periodic benefit
cost for the plan for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
--------- --------- ---------
COMPONENTS OF NET PERIODIC
BENEFIT COST
Service cost $ 371,747 $ 270,440 $ 215,762
Interest cost 360,435 300,755 278,253
Expected return on plan assets (309,775) (324,326) (399,914)
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) loss 50,832 -- (36,181)
--------- --------- ---------
Net periodic benefit cost $ 462,026 $ 235,656 $ 46,707
========= ========= =========
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The assumptions used in the measurement of the Corporation's benefit
obligation and net periodic benefit cost are shown in the following
table:
2003 2002 2001
---- ---- ----
WEIGHTED-AVERAGE ASSUMPTIONS
AS OF DECEMBER 31
Discount rate 6.5% 7.0% 7.5%
Expected return on plan assets 8.5% 9.0% 9.0%
Rate of compensation increase 5.0% 5.0% 5.0%
The plan sponsor selects the expected long-term
rate-of-return-on-assets assumption in consultation with their advisors
and actuary. This rate is intended to reflect the average rate of
earnings expected to be earned on the funds invested or to be invested
to provide plan benefits. Historical performance is reviewed especially
with respect to real rates of return (net of inflation) - for the major
asset classes held or anticipated to be held by the trust, and for the
trust itself. Undue weight is not given to recent experience - that may
not continue over the measurement period - with higher significance
placed on current forecasts of future long-term economic conditions.
Because assets are held in a qualified trust, anticipated returns are
not reduced for taxes. Further, solely for this purpose, the plan is
assumed to continue in force and not terminate during the period during
which assets are invested. However, consideration is given to the
potential impact of current and future investment policy, cash flow
into and out of the trust, and expenses (both investment and
non-investment) typically paid from the plan assets (to the extent such
expenses are not explicitly estimated within periodic costs).
The Corporation pension plan's weighted-average asset allocation at
September 30, 2003 and 2002, by asset category are as follows:
2003 2002
------ ------
ASSET CATEGORY
AS OF SEPTEMBER 30
Mutual Funds - Fixed Income 20.0% 25.0%
Mutual Funds - Equity 80.0% 75.0%
----- -----
Total 100.0% 100.0%
===== =====
The trust fund is sufficiently diversified to maintain a reasonable
level of risk without imprudently sacrificing return, with a targeted
asset allocation of 25% fixed income and 75% equities. The Investment
Manager selects investment fund managers with demonstrated experience
and expertise, and the funds with demonstrated historical performance,
for the implementation of the Plan's investment strategy. The
Investment Manager will consider both actively and passively managed
investment strategies and will allocate funds across the asset classes
to develop an efficient investment structure.
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
It is the responsibility of the Trustee to administer the investments
of the Trust within reasonable costs, being careful to avoid
sacrificing quality. These costs include, but are not limited to,
management and custodial fees, consulting fees, transaction costs and
other administrative costs chargeable to the Trust.
The accumulated benefit obligation for the deferred benefit pension
plan was $3,989,306, $3,258,355, and $2,578,647 at September 30, 2003,
2002, and 2001, respectively.
The Corporation expects to contribute $68,000 to its pension plan in
2004.
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, 2003, 2002 and 2001 of $109,130, $101,265
and $74,880, respectively.
The Corporation has a nonqualified deferred compensation program for a
key employee's retirement, in which the contribution expensed is solely
funded by the Corporation. The retirement benefit to be provided is
fixed based upon the amount of compensation earned and deferred.
Deferred compensation expense amounted to $159,991, $26,050, and
$25,596 for the years ended December 31, 2003, 2002 and 2001,
respectively.
Concurrent with the establishment of the deferred compensation plan,
the Corporation purchased life insurance policies on this employee with
the Corporation named as owner and beneficiary. These life insurance
policies are intended to be utilized as a source of funding the
deferred compensation plan. The Corporation has recorded in other
assets $876,801 and $843,799 representing cash surrender value of these
policies for the years ended December 31, 2003 and 2002, 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. The Bank renewed the lease January 31, 2004. Rent for 2004 is
expected to be $56,228.
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.
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $29,890
with annual increases on the anniversary date based on the CPI, with a
minimum increase of 3%. Rent for 2004 is expected to be $31,259.
Total rent expense was $128,627, $105,072 and $73,076 for 2003, 2002
and 2001, respectively, and was included in occupancy expense.
The following is a schedule by year of future minimum lease
requirements required under the long-term noncancellable lease
agreements:
2004 $124,887
2005 127,301
2006 131,415
2007 118,262
2008 103,016
Thereafter 103,697
--------
Total $708,578
========
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, 2003 and
2002, the aggregate amounts of daily average required balances were
approximately $8,036,000 and $12,416,000, 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.
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. INCOME TAXES
The components of the net deferred tax assets included in other assets
are as follows:
2003 2002
---------- ----------
Deferred tax assets:
Allowance for loan losses $1,081,674 $ 855,440
Accrued pension obligation 57,479 38,090
Interest on nonaccrual loans 86,837 59,282
Accrued vacation 68,027 58,582
SERP obligation 74,413 20,101
---------- ----------
1,368,430 1,031,495
---------- ----------
Deferred tax liabilities:
Securities available for sale 6,708 345,219
Other 702 463
Accumulated depreciation 222,608 175,402
---------- ----------
230,018 521,084
---------- ----------
Net deferred tax assets $1,138,412 $ 510,411
========== ==========
Allocation of federal income taxes between current and deferred
portions is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------------------
2003 2002 2001
----------- ----------- -----------
Current tax expense $ 2,110,799 $ 1,864,972 $ 1,673,861
Deferred tax (benefit) (289,490) (123,229) (77,080)
----------- ----------- -----------
$ 1,821,309 $ 1,741,743 $ 1,596,781
=========== =========== ===========
The reasons for the difference between the statutory federal income tax
rate and the effective tax rates are summarized as follows:
2003 2002 2001
----------- ----------- -----------
Computed "expected" tax expense $ 2,093,434 $ 1,928,330 $ 1,738,153
Decrease in income taxes
resulting from:
Tax-exempt interest income (238,734) (141,582) (135,625)
Other (33,391) (45,005) (5,747)
----------- ----------- -----------
$ 1,821,309 $ 1,741,743 $ 1,596,781
=========== =========== ===========
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. EARNINGS PER SHARE
The following shows the weighted average number of shares used in
computing earnings per share and the effect on the 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.
2003 2002 2001
-------------------- -------------------- --------------------
PER SHARE PER SHARE PER SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
--------- --------- --------- --------- --------- ---------
Basic earnings per share 3,308,124 $ 1.31 3,312,084 $ 1.18 3,406,866 $ 1.03
========= ========= =========
Effect of dilutive securities,
stock options 172,464 148,044 66,830
--------- --------- ---------
Diluted earnings per share 3,480,588 $ 1.24 3,460,128 $ 1.14 3,473,696 $ 1.01
========= ========= ========= ========= ========= =========
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 to
non-employee directors at the discretion of the Compensation and
Benefits Committee. 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.
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 was 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
--------- ---------
Dividend yield 2.84% 2.76%
Expected life 10 years 10 years
Expected volatility 30.82% 18.32%
Risk-free interest rate 5.54% 5.11%
The Corporation did not grant options in 2003.
A summary of the status of the Omnibus Stock Ownership and Long-Term
Incentive Plan and Director compensation plans is presented below:
2003 2002 2001
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
Outstanding at January 1 367,556 $ 8.78 342,224 $ 8.22 259,632 $ 9.23
Granted -- -- 52,130 12.85 84,592 8.07
Exercised (29,174) 7.93 (26,798) 9.23 (2,000) 4.38
--------- --------- ---------
Outstanding at December 31 338,382 $ 8.85 367,556 $ 8.78 342,224 $ 8.22
========= ========= =========
Exercisable at end of year 255,606 233,778 190,562
Weighted-average fair value
per option of options granted
during the year -- $ 6.28 $ 3.11
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The status of the options outstanding as of December 31, 2003 for the
Omnibus Stock Ownership and Long-Term Incentive and Director
Compensation Plans is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------- -----------------------
WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
CONTRACTUAL NUMBER EXERCISE NUMBER EXERCISE
LIFE OUTSTANDING PRICE EXERCISABLE PRICE
----------- ----------- -------- ----------- --------
1.33 years 11,200 $ 4.38 11,200 $ 4.38
2.25 years 18,920 5.06 18,920 5.06
3.25 years 20,160 6.25 20,160 6.25
4.25 years 22,400 10.00 22,400 10.00
4.66 years 9,146 10.50 9,146 10.50
5.25 years 24,140 9.75 24,140 9.75
5.66 years 28,194 9.50 28,194 9.50
6.60 years 67,500 8.13 67,500 8.13
7.88 years 84,592 8.07 28,214 8.07
8.08 years 26,398 12.70 -- --
8.08 years 25,732 13.00 25,732 13.00
------- -------
338,382 $ 8.85 255,606 $ 8.62
======= =======
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.
NOTE 13. FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS
The Corporation's fixed-rate debt of $20,000,000 at December 31, 2003
matures through 2008. At December 31, 2003 and 2002, the interest rates
ranged from 1.32 percent to 4.89 percent and from 4.51 percent to 4.89
percent, respectively. At December 31, 2003 and 2002, the weighted
average interest rates were 3.81 percent and 4.64 percent,
respectively.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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,
2003, the book value of these loans totaled approximately $110,442,867.
The amount of the available credit is limited to seventy-five percent
of qualifying collateral. Any borrowing in excess of the qualifying
collateral requires pledging of additional assets.
The Bank has an available line of credit with the Federal Home Loan
Bank of Atlanta (FHLB) with a borrowing limit of approximately $60.4
million at December 31, 2003 to provide additional sources of
liquidity, as well as available federal funds purchased lines of credit
with various commercial banks totaling $33.1 million. At December 31,
2003, $20.0 million of the FHLB line of credit and $2.0 million of
federal funds purchased lines of credit were in use.
The contractual maturities of FHLB advances are as follows:
DECEMBER 31,
2003
------------
Due in 2004 $ 5,000,000
Due in 2006 10,000,000
Due in 2008 5,000,000
------------
$ 20,000,000
============
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, 2003, the aggregate amount of unrestricted funds, which could be
transferred from the banking subsidiary to the parent corporation,
without prior regulatory approval, totaled $5,654,292.
NOTE 15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Corporation 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.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2003 and 2002, the following financial instruments were
outstanding whose contract amounts represent credit risk:
2003 2002
----------- -----------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $70,158,000 $42,101,000
Standby letters of credit 6,192,000 5,010,000
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.
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.
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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, 2003 and 2002, the fair value of loan commitments
and standby letters of credit were deemed immaterial.
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair values of the Corporation's financial
instruments are as follows:
2003 2002
------------------ ------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(Thousands) (Thousands)
Financial assets:
Cash and short-term
investments $ 11,950 $ 11,950 $ 20,037 $ 20,037
Federal funds sold -- -- 4,900 4,900
Securities 52,386 52,386 71,737 71,737
Loans, net 295,312 293,470 213,698 215,396
Accrued interest receivable 1,233 1,233 1,240 1,240
Financial liabilities:
Deposits $321,129 $271,663 $273,668 $273,631
FHLB advances 20,000 20,413 15,000 16,354
Federal funds purchased 2,000 2,000 -- --
Company obligated manditorily
redeemable capital securities 4,000 3,023 4,000 4,006
Accrued interest payable 394 394 417 417
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.
NOTE 17. OTHER OPERATING EXPENSES
The principal components of "Other operating expenses" in the
Consolidated Statements of Income are:
2003 2002 2001
---------- ---------- ----------
Advertising and business development $ 237,600 $ 418,305 $ 398,694
Bank card 545,313 464,477 426,738
Data processing 887,627 859,522 719,820
Postage and supplies 366,245 387,825 385,291
Professional and consulting fees 564,014 717,899 700,086
Other (no items exceed 1% of total revenue) 2,085,959 1,783,751 1,429,901
---------- ---------- ----------
$4,686,758 $4,631,779 $4,060,530
========== ========== ==========
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $573,141 at December 31, 2003.
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, 2003 and 2002, that
the Corporation and the Bank met all capital adequacy requirements to
which they are subject.
As of December 31, 2003, 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.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
------- ----- ------ ----- ------ -----
(Amount in Thousands)
As of December 31, 2003:
Total Capital (to Risk
Weighted Assets):
Consolidated $35,850 12.8% $22,474 8.0% N/A N/A
The Fauquier Bank $35,738 12.7% $22,468 8.0% $28,085 10.0%
Tier 1 Capital (to Risk
Weighted Assets):
Consolidated $32,339 11.5% $11,237 4.0% N/A N/A
The Fauquier Bank $32,227 11.5% $11,234 4.0% $16,851 6.0%
Tier 1 Capital (to
Average Assets):
Consolidated $32,339 8.6% $15,072 4.0% N/A N/A
The Fauquier Bank $32,227 8.6% $15,071 4.0% $18,839 5.0%
As of December 31, 2002:
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%
32
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 2003, the interest rates ranged from
4.61% to 5.00%. At December 31, 2003 the weighted-average interest rate
was 4.87%. 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 subordinate 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 payment on the junior subordinated
debt securities, which would result in a deferral of distribution
payments on the related Capital Securities.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21. PARENT CORPORATION ONLY FINANCIAL STATEMENTS
FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
BALANCE SHEETS
December 31, 2003 and 2002
DECEMBER 31,
----------------------------
2003 2002
----------- -----------
ASSETS
Cash on deposit with subsidiary bank $ 295,608 $ 246,995
Investment in subsidiaries, at cost,
plus equity in undistributed net income 32,391,802 30,373,777
Dividend receivable 430,590 363,447
Other assets 155,247 122,947
----------- -----------
Total assets $33,273,247 $31,107,166
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Company-obligated mandatorily redeemable capital securities 4,124,000 $ 4,124,000
Dividend payable 430,590 363,447
Other liabilities 255,872 188,554
----------- -----------
4,810,462 4,676,001
----------- -----------
SHAREHOLDERS' EQUITY
Common stock 10,367,280 10,341,726
Retained earnings, which are substantially
distributed earnings of subsidiaries 18,082,684 15,419,307
Accumulated other comprehensive income 12,821 670,132
----------- -----------
28,462,785 26,431,165
----------- -----------
Total liabilities and shareholders' equity $33,273,247 $31,107,166
=========== ===========
34
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, 2003
2003 2002 2001
----------- ----------- -----------
REVENUE,
dividends from subsidiaries $ 1,888,130 $ 2,277,687 $ 2,530,732
----------- ----------- -----------
EXPENSES
Interest expense 194,897 170,379 --
Legal and professional fees 46,129 101,073 28,624
Directors' fees 30,544 53,010 52,432
Miscellaneous 73,303 76,889 35,963
----------- ----------- -----------
Total expenses 344,873 401,351 117,019
----------- ----------- -----------
Income before income tax benefit
and equity in undistributed net
income of subsidiaries 1,543,257 1,876,336 2,413,713
Income tax (benefit) (117,257) (136,459) (39,786)
----------- ----------- -----------
Income before equity in
undistributed net income
of subsidiaries 1,660,514 2,012,795 2,453,499
Equity in undistributed net income
of subsidiaries 2,675,336 1,917,021 1,061,935
----------- ----------- -----------
Net income $ 4,335,850 $ 3,929,816 $ 3,515,434
=========== =========== ===========
35
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, 2003
2003 2002 2001
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income 4,335,850 $ 3,929,816 $ 3,515,434
Adjustments to reconcile net income to net cash
provided by operating activities:
Undistributed earnings of subsidiaries (2,675,336) (1,917,021) (1,061,935)
(Increase) in undistributed dividends
receivable from subsidiaries (67,143) (45,091) (27,284)
Tax benefit of nonqualified options exercised (64,307) (17,114) --
(Increase) decrease in other assets 32,007 254,822 (377,769)
Increase (decrease) in other liabilities 67,318 19,372 43,465
----------- ----------- -----------
Net cash provided by operating activities 1,628,389 2,224,784 2,091,911
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of capital securities -- 4,124,000 --
Contribution of capital to subsidiaries -- (4,124,000) --
Cash dividends paid (1,520,987) (1,310,949) (1,194,739)
Issuance of common stock 295,697 307,520 28,309
Acquisition of common stock (354,486) (1,050,524) (895,941)
----------- ----------- -----------
Net cash (used in) financing activities (1,579,776) (2,053,953) (2,062,371)
----------- ----------- -----------
Increase in cash and cash equivalents 48,613 170,831 29,540
CASH AND CASH EQUIVALENTS
Beginning 246,995 76,164 46,624
----------- ----------- -----------
Ending $ 295,608 $ 246,995 $ 76,164
=========== =========== ===========
36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. 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
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.
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. 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
their evaluation, concluded that our disclosure controls and procedures were
operating effectively.
There were no changes in Bankshares' internal control over financial reporting
during the quarter ended December 31, 2003 that have materially affected, or are
reasonably likely to materially affect, Bankshares' internal control over
financial reporting.
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 2004 annual meeting of
shareholders to be held on May 18, 2004 (the "2004 proxy statement") under the
captions "Election of Class II Directors," "Meetings and Committees of the Board
of Directors," and "Section 16(a) Beneficial Ownership Reporting Compliance,"
and is incorporated herein by reference.
Bankshares has adopted a Code of Business Conduct and Ethics that applies to the
directors, executive officers and employees of Bankshares and TFB. A copy of
this Code is attached hereto as Exhibit 14.
34
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive and director compensation is contained in
Bankshares' 2004 proxy statement under the captions "Compensation of Management"
and "Report of the Compensation and Benefits Committees on Executive
Compensation" and is incorporated herein by reference. The information in the
2004 proxy statement under the caption "Stock Performance" is also incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information regarding security ownership required by this item is contained
in Bankshares' 2004 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, 2003 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 241,562 $9.37 295,646 (1)
- ------------------------------------------------------------------------------------------------------
Equity compensation plans
not approved by security
holders 96,820 $7.54 87,072 (2)
- ------------------------------------------------------------------------------------------------------
TOTAL 338,382 $8.85 382,718
======================================================================================================
(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 Directors 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' 2004 proxy
statement under the caption "Related Party Transactions," and is incorporated
herein by reference.
35
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this item is contained in the 2004 proxy statement under
the captions, "Principal Accounting Fees" and "Pre-Approval Policies," and is
incorporated herein by reference.
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, 2003 and December 31, 2002
Consolidated Statements of Income - Years ended December 31, 2003, 2002
and 2001
Consolidated Statements of Cash Flows - Years ended December 31, 2003,
2002 and 2001
Consolidated Statements of Changes in Shareholders' Equity - December
31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements - Years ended December 31,
2003, 2002 and 2001
(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.
36
10.4 Change of Control Agreement, dated June 13, 1997, between
The Fauquier Bank and C. Hunton Tiffany, incorporated by
reference to Exhibit 10.4 to Form 10-K filed March 25, 2003.
10.5 Change of Control Agreement, dated June 13, 1997, between
The Fauquier Bank and Randy K. Ferrell, incorporated by
reference to Exhibit 10.5 to Form 10-K filed March 25, 2003.
10.6 Change of Control Agreement, dated June 13, 1997, between
The Fauquier Bank and Gary R. Shook, incorporated by
reference to Exhibit 10.6 to Form 10-K filed March 25, 2003.
10.7 Change of Control Agreement, dated December 18, 2000, between
The Fauquier Bank and Rosanne T. Gorkowski, incorporated
by reference to Exhibit 10.7 to Form 10-K filed March 25, 2003.
10.8 Change of Control Agreement, dated November 27, 2000, between
The Fauquier Bank and Eric P. Graap, incorporated by
reference to Exhibit 10.8 to Form 10-K filed March 25, 2003.
10.9 Change of Control Agreement, dated February 22, 2002, between
The Fauquier Bank and Mark A. Debes, incorporated by
reference to Exhibit 10.9 to Form 10-K filed March 25, 2003.
10.10 Executive Supplemental Retirement Plan Agreement, dated August
20, 2000, between The Fauquier Bank and C. Hunton
Tiffany, incorporated by reference to Exhibit 10.10 to Form 10-K
filed March 25, 2003.
10.11 Life Insurance Endorsement Method Split Dollar Plan Agreement,
dated August 10, 2000, between The Fauquier Bank and
C. Hunton Tiffany, incorporated by reference to Exhibit 10.11 to
Form 10-K filed March 25, 2003.
10.12 Life Insurance Endorsement Method Split Dollar Plan Agreement,
dated November 26, 1996, between The Fauquier Bank and
Randy K. Ferrell, incorporated by reference to Exhibit 10.12 to
Form 10-K filed March 25, 2003.
10.13 Form of the Executive Survivor Income Agreement, dated on or
about May 9, 2003, between The Fauquier Bank and each of C.
Hunton Tiffany, Randy K. Ferrell, Gary R. Shook, Eric P. Graap,
and Rosanne T. Gorkowski, incorporated by reference to Exhibit
10.13 to Form 10-Q filed August 14, 2003.
14 Code of Business Conduct and Ethics.
21 Subsidiaries of the Registrant, incorporated herein by reference
to Part I of this Form 10-K.
23 Consent of Yount, Hyde & Barbour, P.C.
31.1 Certification of CEO pursuant to Rule 13a-14(a).
31.2 Certification of CFO pursuant to Rule 13a-14(a).
32.1 Certification of CEO pursuant to 18 U.S.C. Section 1350.
32.2 Certification of CFO pursuant to 18 U.S.C. Section 1350.
37
(b) Reports on Form 8-K:
Current report on Form 8-K filed on October 17, 2003
commenting on third quarter 2003 earnings.
38
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.
(Registrant)
/s/ C. Hunton Tiffany
- -------------------------------------------------
C. Hunton Tiffany
Chairman and Chief Executive Officer
Dated: March 30, 2004
/s/ Randy K. Ferrell
- -------------------------------------------------
Randy K. Ferrell
President and Chief Operating Officer
Dated: March 30, 2004
/s/ Eric P. Graap
- -------------------------------------------------
Eric P. Graap
Senior Vice President and Chief Financial Officer
Dated: March 30, 2004
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 Chairman and Chief Executive Officer March 30, 2004
- --------------------------- Director
C. Hunton Tiffany (principal executive officer)
/s/ Randy K. Ferrell President and Chief Operating Officer, March 30, 2004
- --------------------------- Director
Randy K. Ferrell
/s/ Eric P. Graap Senior Vice President and Chief Financial March 30, 2004
- --------------------------- Officer
Eric P. Graap (principal financial and accounting officer)
/s/ John B. Adams, Jr. Director March 30, 2004
- ---------------------------
John B. Adams, Jr
/s/ Alexander G. Green, Jr. Director March 30, 2004
- ---------------------------
Alexander G. Green, Jr.
/s/ Stanley C. Haworth Director March 30, 2004
- ---------------------------
Stanley C. Haworth
/s/ John J. Norman, Jr Director March 30, 2004
- ---------------------------
John J. Norman, Jr.
/s/ Douglas C. Larson Director March 30, 2004
- ---------------------------
Douglas C. Larson
39
/s/ C.H. Lawrence, Jr Director March 30, 2004
- ---------------------------
C.H. Lawrence, Jr.
/s/ D. Harcourt Lees, Jr. Director March 30, 2004
- ---------------------------
D. Harcourt Lees, Jr.
/s/ Randolph T. Minter Director March 30, 2004
- ---------------------------
Randolph T. Minter
/s/ B.S. Montgomery Director March 30, 2004
- ---------------------------
B.S. Montgomery
/s/ H.P. Neale Director March 30 2004
- ---------------------------
H.P. Neale
/s/ Pat H. Nevill Director March 30, 2004
- ---------------------------
Pat H. Nevill
/s/ H. Frances Stringfellow Director March 30, 2004
- ---------------------------
H. Frances Stringfellow
40