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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
__________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
(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, 2002
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. 333-59338
__________________
FIRST SECURITY GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
TENNESSEE 58-2461486
(State of Incorporation) (I.R.S. Employer Identification No.)
817 BROAD STREET, CHATTANOOGA, TN 37402
(Address of principal executive offices) (Zip Code)
(423) 266-2000
(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, $.01 PAR VALUE
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 and 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 (229.405 of this chapter) 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. [ ]
As of March 14, 2003, the aggregate market value of voting stock held by
non-affiliates of the Registrant was approximately $68,948,750.
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Common Stock, $.01 par value:
7,579,104 shares outstanding as of March 14, 2003
Documents Incorporated by Reference: Portions of the Registrant's Proxy
Statement for the Annual Meeting of Shareholders to be held on May 22, 2003 are
incorporated by reference into Part III of this Form 10-K.
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TABLE OF CONTENTS
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . 4
ITEM 2. PROPERTIES. . . . . . . . . . . . . . . . . . . . . . . . 14
ITEM 3. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . . . 15
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS . . . . . . . . . . . . . . . . . . . 16
ITEM 6. SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . . . 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION. . . . . . . . . . . . 20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK. . . . . . . . . . . . . . . . . . . . . . . 41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA . . . . . . . 43
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES. . . . . . . . . . . 72
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS . . . . . . . . . . . . 72
ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . 76
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT . . . . . . . . . . . . . . . . . . . . . 78
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTION. . . . . . 79
ITEM 14. CONTROLS AND PROCEDURES. . . . . . . . . . . . . . . . . 79
PART IV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
CERTIFICATION OF CHIEF EXECUTIVE OFFICER . . . . . . . . . . . . . . . . . 72
CERTIFICATION OF CHIEF FINANCIAL OFFICER . . . . . . . . . . . . . . . . . 72
1
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Various statements made under the caption "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere
throughout this Annual Report are forward-looking statements for purposes of the
Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking
statements relate to future events or our future financial performance and may
involve known or unknown risks, uncertainties, and other factors which may cause
the actual results, performance, financial condition, or achievements of First
Security to be materially different from future results, performance, financial
condition, or achievements expressed or implied by such forward-looking
statements. Forward-looking statements include statements using the words such
as "may," "will," "anticipate," "should," "would," "assure," "believe,"
"contemplate," "expect," "estimate," "project," "continue," "may," "intend,"
"design, " "seeks," or similar words and expressions of the future.
These forward-looking statements involve risks and uncertainties and may
not be realized due to a variety of factors, including, but not limited to the
following:
- the effects of future economic conditions;
- governmental monetary and fiscal policies, as well as legislative
and regulatory changes;
- the risks of changes in interest rates on the level and composition of
deposits, loan demand, and the values of loan collateral, securities,
and interest sensitive assets and liabilities;
- interest rate and credit risks;
- the effects of competition from other commercial banks, thrifts,
mortgage banking firms, consumer finance companies, credit unions,
securities brokerage firms, insurance companies, money market and
other mutual funds, and other financial institutions operating in
First Security's market area and elsewhere, including institutions
operating regionally, nationally, and internationally, together with
such competitors offering banking products and services by mail,
telephone, and the Internet;
- the effect of any mergers, acquisitions or other transactions to which
First Security or its subsidiaries may from time to time be a party,
including, without limitation, First Security's ability to
successfully integrate any businesses that it acquires; and
- the failure of assumptions underlying the establishment of reserves
for possible loan losses.
All written or oral forward-looking statements attributable to First
Security are expressly qualified in their entirety by this Special Note. Our
actual results may differ significantly from those we discuss in these
forward-looking statements.
2
PART I
ITEM 1. DESCRIPTION OF BUSINESS
OUR COMPANY
GENERAL
First Security was incorporated in 1999, and is a bank holding company
regulated and supervised by the Board of the Federal Reserve System and the
Georgia Department of Banking and Finance. The Tennessee Department of Financial
Institutions does not regulate bank holding companies. First Security became the
parent holding company of Dalton Whitfield Bank on September 16, 1999, Frontier
Bank on June 24, 2000, and First State Bank on July 20, 2002. As of December 31,
2002, First Security and its subsidiaries had total assets of approximately
$472.9 million, total deposits of approximately $384.5 million, and
shareholders' equity of approximately $67.9 million.
Dalton Whitfield Bank is a Georgia banking corporation engaged in the
general commercial banking business since it opened for business in September
1999. At that time, Dalton Whitfield Bank, being newly formed, acquired selected
assets and substantially all of the deposits of Colonial Bank's three branches
located in Dalton, Georgia. Colonial had acquired these operations in January
1997. Specifically, on September 16, 1999, we assumed $70.3 million of
liabilities (including deposits and accrued interest) which exceeded the total
estimated fair value of the assets acquired and cash received from Colonial Bank
by $6.2 million, which was determined to be goodwill.
Dalton Whitfield Bank's deposits are insured by the FDIC. Dalton Whitfield
Bank is also a member of the Federal Home Loan Bank of Atlanta. Through Dalton
Whitfield Bank, First Security provides a broad range of banking and financial
services in Dalton, Georgia.
Frontier Bank is a Tennessee banking corporation that has engaged in the
general commercial banking business since it was chartered in June 2000.
Frontier Bank's deposits are insured by the FDIC. Frontier Bank is a member of
the Federal Home Loan Bank of Cincinnati. Through Frontier Bank, First Security
provides a wide range of banking and financial services in Chattanooga,
Sweetwater, Athens, and Lenoir City, Tennessee. In addition, Frontier Bank has a
loan production office in Loudon, Tennessee. Outside of the Chattanooga market,
Frontier Bank operates under the name of "First Security Bank."
First State Bank is also a Tennessee banking corporation engaged in the
general commercial banking business since it opened in 1974. On July 20, 2002,
First Security acquired all of First State Bank's outstanding common stock for
an aggregate purchase price of $8.6 million, which was paid in cash. The
purchase price included $8.2 million to First State Bank's shareholders and $438
thousand in acquisition costs, such as legal, accounting and investment banking
fees. The transaction resulted in $1.4 million of goodwill and $1.0 million of
core deposit intangibles. The amount allocated to the core deposit intangible
was determined by an independent valuation and is being amortized over the
estimated useful life of ten years using an accelerated basis reflecting the
pattern of the expected run off of the related deposits.
First State Bank's deposits are insured by the FDIC. First State Bank is a
member of the Federal Home Loan Bank of Cincinnati. Through First State Bank,
First Security provides a wide range of banking and financial services in
Maynardville and Jefferson City, Tennessee. In addition, First State Bank has
loan production offices in Knoxville and Dandridge, Tennessee. Outside of the
Maynardville market, First State Bank operates under the name of "FSGBank."
Our goal is to offer personalized and flexible banking services to the
communities in our primary market areas.
3
BUSINESS STRATEGY
First Security contemplates serving the banking and financial needs of the
various communities in and around the interstate corridors between Cartersville,
Georgia and Knoxville, Tennessee. We believe these interstate corridors offer
opportunities for growth and have needs that we can serve effectively. These
communities are primarily served by branches of large regional and national
financial institutions headquartered outside of the area. As a result, we
believe these markets need and are best served by a locally-owned and operated
financial institution managed by people in and from the communities served.
Although these interstate corridors are our primary focus, we may consider
acquiring banking operations outside of the corridors if attractive
opportunities arise as we continuously evaluate acquisition opportunities.
We offer personalized and flexible banking services to the communities in
our market area and are able to react quickly to changes in those communities.
We also offer products tailored to the specific needs of our communities.
COMMERCIAL BANKING OPERATIONS
The commercial banking operations of our bank subsidiaries are primarily
retail-oriented and aimed at individuals and small to medium-sized local
businesses.
Dalton Whitfield Bank considers its primary market area for commercial
banking services to be Whitfield County, Georgia, which is north of Atlanta.
Frontier Bank considers its primary market area for commercial banking services
to be Hamilton, Monroe, McMinn, and Loudon Counties, Tennessee. First State Bank
considers its target market to include Union, Jefferson, and Knox Counties,
Tennessee.
Our subsidiary banks provide traditional banking services, which includes
taking of demand and time deposits and the making of secured and unsecured
consumer loans and commercial loans to small and medium-sized businesses.
The retail nature of the commercial banking operations for our subsidiaries
allows for diversification of depositors and borrowers, and management believes
that no subsidiary depends upon a single or a few customers. As of December 31,
2002, First Security had an approximately $17 million concentration of
carpet-industry related commercial banking loans. Otherwise, we do not believe
our credits are concentrated within a single industry or group of related
industries.
MORTGAGE BANKING OPERATIONS
First Security's mortgage banking operations depend upon traditional
financing sources, such as deposits, to fund the origination and holding of
mortgage loans pending sale in the secondary market. Currently, we sell
substantially all of the mortgage loans we originate, and the purchaser of these
mortgage loans also acquires the rights to service such loans.
Economic slowdowns or recessions in our primary market areas or higher
interest rates may be accompanied by reduced demand for consumer credit and
declining real estate values, which usually results in a slowdown in mortgage
lending activity. Generally, any sustained period of decreased economic activity
or higher interest rates could adversely affect our mortgage originations and,
consequently, reduce our noninterest income from mortgage banking activity.
We depend largely on financial institutions and mortgage bankers to
purchase our mortgage loans. Our future results may become more exposed to
fluctuations resulting from competition from other originators of such loans,
market conditions, and other factors.
4
SEASONALITY, CYCLES
Although we do not consider our commercial banking business to be seasonal,
our mortgage banking business is somewhat seasonal, with the volume of home
financings, in particular, being lower during the winter months. The Dalton,
Georgia economy also is seasonal and cyclical as a result of its dependence upon
the carpet industry and changes in construction of residential and commercial
establishments. While the Dalton, Georgia economy is dominated by the carpet and
carpet-related industries, Dalton Whitfield Bank does not have any one customer
from whom more than 10% of its revenues are derived. However, Dalton Whitfield
Bank has multiple customers, commercial and retail, that are affected by, or are
engaged in businesses related to the carpet industry that, in the aggregate,
have historically provided greater than 10% of Dalton Whitfield Bank's revenues.
COMPETITION
The retail, commercial, and mortgage divisions of our Bank subsidiaries
operate in highly competitive markets. We compete directly in retail and
commercial banking markets with other commercial banks, savings and loan
associations, credit unions, mortgage brokers and mortgage companies, mutual
funds, securities brokers, consumer finance companies, other lenders, and
insurance companies, locally, regionally, and nationally, certain of which
compete with offerings by mail, telephone, computer, and/or the Internet.
Interest rates, both on loans and deposits, and prices of services are
significant competitive factors among financial institutions generally. We
believe that office locations, types and quality of services and products,
office hours, customer service, a local presence, community reputation, and
continuity of personnel also are important competitive factors which we
emphasize.
In addition to Dalton Whitfield Bank, 13 other commercial or savings
institutions currently have offices in the Dalton, Georgia area. Many of the
largest banks operating in Georgia, including some of the largest banks in the
country, also have offices within this market. Also, along with Frontier Bank,
11 other commercial or savings institutions have offices in the Chattanooga
area; eight other commercial or savings institutions have offices in the
Sweetwater area of Monroe County, Tennessee; eight other commercial or savings
institutions have offices in the Athens area of McMinn County, Tennessee; and
six other commercial banks have offices in the Lenoir City area of Loudon
County, Tennessee. First State Bank is accompanied by two other commercial banks
in the Maynardville area of Union County, Tennessee and five other commercial or
savings institutions in the Jefferson City area of Jefferson County, Tennessee.
Virtually every type of competitor for business of the type served by our
Banks has offices in Atlanta, approximately 75 miles away from Dalton and 100
miles from Chattanooga. Many of these institutions have greater resources, have
broader geographic markets, have higher lending limits, offer various services
that we do not offer, and can better afford and make broader use of media
advertising, support services, and electronic technology than our Banks. To
offset these competitive disadvantages, our Banks depend on their reputations as
being independent and locally-owned community banks and as having greater
personal service, community involvement, and their ability to make credit and
other business decisions quickly and locally.
EMPLOYEES
On December 31, 2002, we had 182 full-time employees and seven part-time
employees. Our staff will increase as a result of the Premier National Bank
merger (discussed below), as well as branch openings anticipated in 2003. First
Security considers our employee relations to be good, and we have no collective
bargaining agreements with any employees.
5
RECENT DEVELOPMENTS
Premier National Bank of Dalton Acquisition
On November 19, 2002, we entered into an Agreement and Plan of Merger among
First Security, Dalton Whitfield Bank, and Premier National Bank of Dalton.
Premier National Bank of Dalton is located in Dalton, Georgia. The Plan of
Merger provides that Premier National Bank of Dalton will merge with and into
Dalton Whitfield Bank, with Premier National Bank of Dalton shareholders
receiving 0.425 shares of First Security common stock in the merger in exchange
for each share of Premier National Bank of Dalton common stock they own. First
Security anticipates consummating the transaction in the first quarter of 2003.
As of December 31, 2002, Premier National Bank of Dalton had consolidated
assets of approximately $84.7 million, consolidated deposits of approximately
$73.4 million, and consolidated shareholders' equity of approximately $7.1
million.
Conversion to OCC Charters
Recently, we began to undertake the process to convert our separate state
banking charters to separate national banking charters. Upon completing the
conversion process, our Banks' primary regulator will become the Office of the
Comptroller of the Currency. Furthermore, and as part of the conversion, we
anticipate changing the name of each of our Banks to FSGBank. By making this
change, we would have a single branded identity across our markets.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both
federal and state law. The following discussion summarizes various statutes,
rules, and regulations affecting First Security, Dalton Whitfield Bank, Frontier
Bank and First State Bank. This summary is qualified in its entirety by
reference to the statutory and regulatory provisions referred to below and
elsewhere and is not intended to be an exhaustive description of the statutes or
regulations applicable to First Security's and our Banks' businesses. Any change
in the applicable law or regulations may have a material effect on our business.
Supervision, regulation, and examination of banks by the bank regulatory
agencies are intended primarily for the protection of depositors rather than
holders of First Security's common stock.
BANK HOLDING COMPANY REGULATION
GENERAL. First Security is a bank holding company, under the Bank Holding
Company Act of 1956, as amended and under the Financial Institutions Code of
Georgia. We are subject to supervision, examination, and reporting by the
Federal Reserve and the Georgia Department. The Tennessee Department of
Financial Institutions does not regulate bank holding companies. First Security
is required to file with the Federal Reserve periodic reports and such
additional information as the Federal Reserve may require. The Federal Reserve
examines First Security and may examine its nonbank subsidiaries. The Georgia
Department also may examine First Security.
ACQUISITIONS OF BANKS. The Bank Holding Company Act requires every bank
holding company to obtain the Federal Reserve's prior approval before:
- acquiring direct or indirect ownership or control of any voting shares
of any bank if, after the acquisition, the bank holding company will
directly or indirectly own or control more than 5% of the bank's
voting shares;
- acquiring all or substantially all of the assets of any bank; or
6
- merging or consolidating with any other bank holding company.
Additionally, the Bank Holding Company Act provides that the Federal
Reserve may not approve any of these transactions if it would result in or tend
to create a monopoly or, substantially lessen competition or otherwise function
as a restraint of trade, unless the anti-competitive effects of the proposed
transaction are clearly outweighed by the public interest in meeting the
convenience and needs of the community to be served. The Federal Reserve is also
required to consider the financial and managerial resources and future prospects
of the bank holding companies and banks concerned and the convenience and needs
of the community to be served. The Federal Reserve's consideration of financial
resources generally focuses on capital adequacy, which is discussed below.
Under the Bank Holding Company Act, if adequately capitalized and
adequately managed, the Company may purchase a bank located outside of Georgia
or Tennessee. Conversely, an adequately capitalized and adequately managed bank
holding company located outside of Georgia or Tennessee may purchase a bank
located inside Georgia or Tennessee. In each case, however, restrictions may be
placed on the acquisition of a bank that has only been in existence for a
limited amount of time or will result in specified concentrations of deposits.
For example, Georgia law prohibits a bank holding company from acquiring control
of a financial institution until the target financial institution has been
incorporated for three years, and Tennessee Law prohibits a bank holding company
from acquiring control of a financial institution until the target financial
institution has been incorporated for five years.
CHANGE IN BANK CONTROL. Subject to various exceptions, the Bank Holding
Company Act and the Change in Bank Control Act, together with related
regulations, require Federal Reserve approval prior to any person or company
acquiring "control" of a bank holding company. Control is conclusively presumed
to exist if an individual or company acquires 25% or more of any class of voting
securities of the bank holding company. Control is rebuttably presumed to exist
if a person or company acquires 10% or more, but less than 25%, of any class of
voting securities and either:
- the bank holding company has registered securities under Section 12 of
the Securities Act of 1934; or
- no other person owns a greater percentage of that class of voting
securities immediately after the transaction.
Our common stock is registered under Section 12 of the Securities Exchange Act
of 1934. The regulations provide a procedure for challenging any rebuttable
presumption of control.
PERMITTED ACTIVITIES. A bank holding company is generally permitted under
the Bank Holding Company Act, to engage in or acquire direct or indirect control
of more than 5% of the voting shares of any company engaged in the following
activities:
- Banking or managing or controlling banks; and
- Any activity that the Federal Reserve determines to be so closely
related to banking as to be a proper incident to the business of
banking.
Activities that the Federal Reserve has found to be so closely related to
banking as to be a proper incident to the business of banking include:
- Factoring accounts receivable;
- Making, acquiring, brokering or servicing loans and usual related
activities;
- Leasing personal or real property;
- Operating a non-bank depository institution, such as a savings
association;
7
- Trust company functions;
- Financial and investment advisory activities;
- Conducting discount securities brokerage activities;
- Underwriting and dealing in government obligations and money market
instruments;
- Providing specified management consulting and counseling activities;
- Performing selected data processing services and support services;
- Acting as agent or broker in selling credit life insurance and other
types of insurance in connection with credit transactions; and
- Performing selected insurance underwriting activities.
Despite prior approval, the Federal Reserve may order a bank holding
company or its subsidiaries to terminate any of these activities or to terminate
its ownership or control of any subsidiary when it has reasonable cause to
believe that the bank holding company's continued ownership, activity or control
constitutes a serious risk to the financial safety, soundness, or stability of
it or any of its bank subsidiaries.
In addition to the permissible bank holding company activities listed
above, a bank holding company may qualify and elect to become a financial
holding company, permitting the bank holding company to engage in additional
activities that are financial in nature or incidental or complementary to
financial activity. The Bank Holding Company Act expressly lists the following
activities as financial in nature:
- Lending, trust and other banking activities;
- Insuring, guaranteeing, or indemnifying against loss or harm, or
providing and issuing annuities, and acting as principal, agent, or
broker for these purposes, in any state;
- Providing financial, investment, or advisory services;
- Issuing or selling instruments representing interests in pools of
assets permissible for a bank to hold directly;
- Underwriting, dealing in or making a market in securities;
- Other activities that the Federal Reserve may determine to be so
closely related to banking or managing or controlling banks as to be a
proper incident to managing or controlling banks;
- Foreign activities permitted outside of the United States if the
Federal Reserve has determined them to be usual in connection with
banking operations abroad;
- Merchant banking through securities or insurance affiliates; and
- Insurance company portfolio investments.
To qualify to become a financial holding company, the Banks must be well
capitalized and well managed and must have a Community Reinvestment Act rating
of at least "satisfactory." Additionally, the Company must file an election with
the Federal Reserve to become a financial holding company and must provide the
Federal Reserve with 30 days' written notice prior to engaging in a permitted
financial activity. While the Company meets the qualification standards
applicable to financial holding companies, the Company has not elected to become
a financial holding company at this time.
SUPPORT OF SUBSIDIARY INSTITUTIONS. Under Federal Reserve policy, the
Company is expected to act as a source of financial strength for the Banks and
to commit resources to support the Banks. This support may be required at times
when, without this Federal Reserve policy, the Company might not be inclined to
provide it. In addition, any capital loans made by the Company to the Banks will
be repaid only
8
after its deposits and various other obligations are repaid in full. In the
unlikely event of the Company's bankruptcy, any commitment by it to a federal
bank regulatory agency to maintain the capital of any Bank will be assumed by
the bankruptcy trustee and entitled to a priority of payment.
BANK REGULATION
GENERAL. Dalton Whitfield Bank is a Georgia-chartered bank subject to
regulation and examination by the Georgia Department of Banking and Finance.
Frontier Bank and First State Bank are Tennessee-chartered banks subject to
regulation and examination by the Tennessee Department of Financial
Institutions. Each of the Banks is a member of the FDIC, and each Bank's
deposits are insured up to the maximum permitted by law. The FDIC and the
respective state regulatory agencies regulate, examine and monitor all of the
Banks' operations, including reserves, loans, mortgages, payments of dividends,
interest rates, and the establishment of branches. Interest and other charges
collected or contracted for by the Banks are subject to state usury laws and
various federal laws concerning interest rates.
The Federal Reserve has adopted the Federal Financial Institutions
Examination Council's ("FFIEC") internal rating system to assess the soundness
of financial institutions on a uniform basis and to identify situations
requiring special supervisory attention. Each financial institution is assigned
a confidential composite "CAMELS" rating based on an evaluation and rating of
six essential components of an institution's financial condition and operations,
including Capital adequacy, Asset quality, Management, Earnings, Liquidity and
Sensitivity to market risk. For most institutions, the FFIEC has indicated that
market risk primarily reflects exposures to changes in interest rates. When
regulators evaluate this component, consideration is expected to be given to
management's ability to identify, measure, monitor, and control market risk; the
institution's size; the nature and complexity of its activities and its risk
profile, and the adequacy of its capital and earnings in relation to its level
of market risk exposure. Market risk is rated based upon, but not limited to, an
assessment of the sensitivity of the financial institution's earnings or the
economic value of its capital to adverse changes in interest rates, foreign
exchange rates, commodity prices, or equity prices; management's ability to
identify, measure, monitor and control exposure to market risk; and the nature
and complexity of interest rate risk exposure arising from nontrading positions.
PRIVACY. Financial institutions are required to disclose their policies for
collecting and protecting confidential information. Customers generally may
prevent financial institutions from sharing nonpublic personal financial
information with nonaffiliated third parties except under narrow circumstances,
such as the processing of transactions requested by the consumer or when the
financial institution is jointly sponsoring a product or service with a
nonaffiliated third party. Additionally, financial institutions generally may
not disclose consumer account numbers to any nonaffiliated third party for use
in telemarketing, direct mail marketing or other marketing to consumers.
BRANCHING. The Banks currently have branches in Tennessee and Georgia. Each
state permits state-wide branching, subject to regulatory approval.
PROMPT CORRECTIVE ACTION. The Federal Deposit Insurance Corporation
Improvement Act of 1991 establishes a system of prompt corrective action to
resolve the problems of undercapitalized financial institutions. Under this
system, the federal banking regulators have established five capital categories
(well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized) in which all institutions are
placed. Federal banking regulators are required to take various mandatory
supervisory actions and are authorized to take other discretionary actions with
respect to institutions in the three undercapitalized categories. The severity
of the action depends upon the capital category in which the institution is
placed. Generally, subject to a narrow exception, the banking regulator must
appoint a receiver or conservator for an institution that is critically
undercapitalized. The federal banking agencies have specified by regulation the
relevant capital level for each category.
An institution that is categorized as undercapitalized, significantly
undercapitalized, or critically undercapitalized is required to submit an
acceptable capital restoration plan to its appropriate federal
9
banking agency. A bank holding company must guarantee that a subsidiary
depository institution meets its capital restoration plan, subject to various
limitations. The controlling holding company's obligation to fund a capital
restoration plan is limited to the lesser of 5% of an undercapitalized
subsidiary's assets at the time it became undercapitalized or the amount
required to meet regulatory capital requirements. An undercapitalized
institution is also generally prohibited from increasing its average total
assets, making acquisitions, establishing any branches or engaging in any new
line of business, except under an accepted capital restoration plan or with FDIC
approval. The regulations also establish procedures for downgrading an
institution to a lower capital category based on supervisory factors other than
capital.
FDIC INSURANCE ASSESSMENTS. The FDIC has adopted a risk-based assessment
system for insured depository institutions that takes into account the risks
attributable to different categories and concentrations of assets and
liabilities. The system assigns an institution to one of three capital
categories: (i) well capitalized; (ii) adequately capitalized; and (iii)
undercapitalized. These three categories are substantially similar to the prompt
corrective action categories described above, with the "undercapitalized"
category including institutions that are undercapitalized, significantly
undercapitalized, and critically undercapitalized for prompt corrective action
purposes. The FDIC also assigns an institution to one of three supervisory
subgroups based on a supervisory evaluation that the institution's primary
federal regulator provides to the FDIC and information that the FDIC determines
to be relevant to the institution's financial condition and the risk posed to
the deposit insurance funds. Assessments range from 0 to 27 cents per $100 of
deposits, depending on the institution's capital group and supervisory subgroup.
In addition, the FDIC imposes assessments to help pay off the $780 million in
annual interest payments on the $8 billion Financing Corporation bonds issued in
the late 1980s as part of the government rescue of the thrift industry. This
assessment rate is adjusted quarterly and is set at 1.68 cents per $100 of
deposits for the first quarter of 2003.
The FDIC may terminate its insurance of deposits if it finds that the
institution has engaged in unsafe and unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, rule, order, or condition imposed by the FDIC.
COMMUNITY REINVESTMENT ACT. The Community Reinvestment Act requires that,
in connection with examinations of financial institutions within their
respective jurisdictions, the Federal Reserve, the FDIC, or the Office of the
Comptroller of the Currency, shall evaluate the record of each financial
institution in meeting the credit needs of its local community, including low
and moderate-income neighborhoods. These facts are also considered in evaluating
mergers, acquisitions, and applications to open a branch or facility. Failure to
adequately meet these criteria could impose additional requirements and
limitations on the Banks Additionally, we must publicly disclose the terms of
various Community Reinvestment Act-related agreements.
OTHER REGULATIONS. Interest and other charges collected or contracted for
by the Banks are subject to state usury laws and federal laws concerning
interest rates. For example, under the Soldiers' and Sailors' Civil Relief Act
of 1940, a lender is generally prohibited from charging an annual interest rate
in excess of 6% on any obligation for which the borrower is a person on active
duty with the United States military.
The Banks' loan operations are also subject to federal laws applicable to
credit transactions, such as the:
- federal Truth-In-Lending Act, governing disclosures of credit terms to
consumer borrowers;
- Home Mortgage Disclosure Act of 1975, requiring financial institutions
to provide information to enable the public and public officials to
determine whether a financial institution is fulfilling its obligation
to help meet the housing needs of the community it serves;
10
- Equal Credit Opportunity Act, prohibiting discrimination on the basis
of race, creed or other prohibited factors in extending credit;
- Fair Credit Reporting Act of 1978, governing the use and provision of
information to credit reporting agencies;
- Fair Debt Collection Act, governing the manner in which consumer debts
may be collected by collection agencies;
- Soldiers' and Sailors' Civil Relief Act of 1940, governing the
repayment terms of, and property rights underlying, secured
obligations of persons in military service; and
- the rules and regulations of the various federal agencies charged with
the responsibility of implementing these federal laws.
In addition to the federal laws noted above, the Georgia Fair Lending Act
("GFLA") imposes new restrictions and procedural requirements on most mortgage
loans made in Georgia, including home equity loans and lines of credit. GFLA
became effective on October 1, 2002 and was amended on March 7, 2003. While
selected provisions of GFLA apply regardless of the interest rate or charges on
the loan, the majority of the requirements apply only to "high cost home loans,"
as defined by GFLA. We have implemented procedures to comply with all GFLA
requirements.
The deposit operations of the Banks are subject to:
- The Right to Financial Privacy Act, which imposes a duty to maintain
confidentiality of consumer financial records and prescribes
procedures for complying with administrative subpoenas of financial
records; and
- The Electronic Funds Transfer Act and Regulation E issued by the
Federal Reserve to implement that act, which govern automatic deposits
to and withdrawals from deposit accounts and customers' rights and
liabilities arising from the use of automated teller machines and
other electronic banking services.
CAPITAL ADEQUACY
The Company and the Banks are required to comply with the capital adequacy
standards established by the Federal Reserve, in the case of the Company, and
the Georgia Department of Banking and Finance and the Tennessee Department of
Financial Institutions, respectively, in the case of the Banks. The Federal
Reserve has established a risk-based and a leverage measure of capital adequacy
for bank holding companies. The Banks are also subject to risk-based and
leverage capital requirements adopted by the FDIC, which are substantially
similar to those adopted by the Federal Reserve for bank holding companies.
The risk-based capital standards are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies, to account for off-balance-sheet exposure, and to minimize
disincentives for holding liquid assets. Assets and off-balance-sheet items,
such as letters of credit and unfunded loan commitments, are assigned to broad
risk categories, each with appropriate risk weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and
off-balance-sheet items.
The minimum guideline for the ratio of total capital to risk-weighted
assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier
2 Capital. Tier 1 Capital generally consists of common stock, minority interests
in the equity accounts of consolidated subsidiaries, noncumulative perpetual
preferred stock, and a limited amount of qualifying cumulative perpetual
preferred stock, less goodwill and other specified intangible assets. Tier 1
Capital must equal at least 4% of risk-weighted assets. Tier 2
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Capital generally consists of subordinated debt, other preferred stock, and a
limited amount of loan loss reserves. The total amount of Tier 2 Capital is
limited to 100% of Tier 1 Capital.
In addition, the Federal Reserve has established minimum leverage ratio
guidelines for bank holding companies. These guidelines provide for a minimum
ratio of Tier 1 Capital to average assets, less goodwill and other specified
intangible assets, of 3% for bank holding companies that meet specified
criteria, including having the highest regulatory rating and implementing the
Federal Reserve's risk-based capital measure for market risk. All other bank
holding companies generally are required to maintain a leverage ratio of at
least 4%. The guidelines also provide that bank holding companies experiencing
internal growth or making acquisitions will be expected to maintain strong
capital positions substantially above the minimum supervisory levels without
reliance on intangible assets. The Federal Reserve considers the leverage ratio
and other indicators of capital strength in evaluating proposals for expansion
or new activities.
Dalton Whitfield Bank and the Company are also both subject to leverage
capital guidelines issued by the Georgia Department of Banking and Finance,
which provide minimum ratios of Tier 1 capital to total assets. These guidelines
are substantially similar to those adopted by the FDIC in the case of the Banks.
Failure to meet capital guidelines could subject a bank or bank holding
company to a variety of enforcement remedies, including issuance of a capital
directive, the termination of deposit insurance by the FDIC, a prohibition on
accepting brokered deposits, and certain other restrictions on its business. As
described above, significant additional restrictions can be imposed on
FDIC-insured depository institutions that fail to meet applicable capital
requirements. See "-Bank Regulation-Prompt Corrective Action."
See Note 15 in the "Notes to Consolidated Financial Statements" for the
capital ratios of the Company and the Banks.
DIVIDENDS
A principal source of First Security's cash revenues are management fees
from its Banks. The amount of dividends that the Banks can pay depends on their
earnings and capital positions.
Cash dividends on Dalton Whitfield Bank's common stock may be declared and
paid without prior regulatory approval only out of its retained earnings for the
current and preceding two years, under FDIC policy, provided its paid-in capital
and appropriated retained earnings equal at least 20% of the capital stock
account. Prior Georgia Department approval is also required before cash
dividends may be declared and paid if (i) a bank's ratio of equity capital to
adjusted total assets is less than 6%; (ii) the aggregate amount of dividends
declared or anticipated to be declared in that calendar year exceeds 50% of the
bank's net profits, after taxes but before dividends, for the previous calendar
year; or (iii) the percentage of the bank's assets classified as adverse as to
repayment or recovery by the Georgia Department at the most recent examination
exceeds 80% of its equity capital as reflected at such examination.
Cash dividends on Frontier Bank's and First State Bank's common stock may
be declared and paid only out of their retained earnings for the current and
preceding two years under FDIC policy, and net profits may be credited to
retained earnings only after the proper deductions have been made for all
expenditures, expenses, taxes, losses, bad debts and any write-offs, or other
deductions as required by the Tennessee Department of Financial Institutions,
provided that surplus is at least 50% of the capital stock and the paid-in
surplus account equals the capital stock account. After these requirements are
met, Frontier Bank and First State Bank may declare dividends if they are
adequately reserved and those reserves will not be impaired by the declaration
of the dividend. Frontier Bank is a recently chartered bank and is prevented
from paying dividends to First Security during its first three years of
operations without prior regulatory approval.
The Company and the Banks are subject to various regulatory policies and
requirements relating to the payment of dividends, including requirements to
maintain adequate capital above regulatory minimums. The appropriate federal and
state regulatory authorities are authorized to determine, under various
12
circumstances relating to the financial condition of a bank or a bank holding
company, that the payment of dividends would be an unsafe or unsound practice
and can prohibit the payment of dividends. Dividends that deplete a bank's
capital base to an inadequate level would be an unsound and unsafe banking
practice. Generally, depository institutions are expected to pay dividends only
out of current operating earnings. In addition, the Federal Reserve has stated
that bank holding companies should refrain from or limit dividend increases or
reduce or eliminate dividends under circumstances in which the bank holding
company fails to meet minimum capital requirements or in which its earnings are
impaired.
TRANSACTIONS WITH AFFILIATES
The Company and the Banks are subject to the provisions of Section 23A of
the Federal Reserve Act. Section 23A places limits on the amount of:
- a bank's loans or extensions of credit to affiliates;
- a bank's investment in affiliates;
- assets a bank may purchase from affiliates, except for real and
personal property exempted by the Federal Reserve;
- loans or extensions of credit to third parties collateralized by the
securities or obligations of affiliates; and
- a bank's guarantee, acceptance or letter of credit issued on behalf of
an affiliate.
The total amount of the above transactions is limited in amount, as to any
one affiliate, to 10% of a bank's capital and surplus and, as to all affiliates
combined, to 20% of a bank's capital and surplus. In addition to the limitation
on the amount of these transactions, each of the above transactions must also
meet specified collateral requirements. The Banks must also comply with other
provisions designed to avoid the taking of low-quality assets.
The Company and the Banks are also subject to the provisions of Section 23B
of the Federal Reserve Act which, among other things, prohibit an institution
from engaging in the above transactions with affiliates unless the transactions
are on terms substantially the same, or at least as favorable to the institution
or its subsidiaries, as those prevailing at the time for comparable transactions
with nonaffiliated companies.
The Banks are also subject to restrictions on extensions of credit to their
executive officers, directors, principal shareholders and their related
interests. These extensions of credit (1) must be made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with third parties, and (2) must not involve more
than the normal risk of repayment or present other unfavorable features.
ANTI-TERRORISM LEGISLATION
In the wake of the tragic events of September 11th, on October 26, 2001,
the President signed the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act
of 2001. Under the USA PATRIOT Act, financial institutions are subject to
prohibitions against specified financial transactions and account relationships
as well as enhanced due diligence and "know your customer" standards in their
dealings with foreign financial institutions and foreign customers. For example,
the enhanced due diligence policies, procedures and controls generally require
financial institutions to take reasonable steps:
- to conduct enhanced scrutiny of account relationships to guard against
money laundering and report any suspicious transaction;
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- to ascertain the identity of the nominal and beneficial owners of, and
the source of funds deposited into, each account as needed to guard
against money laundering and report any suspicious transactions;
- to ascertain for any foreign bank, the shares of which are not
publicly traded, the identity of the owners of the foreign bank and
the nature and extent of the ownership interest of each such owner;
and
- to ascertain whether any foreign bank provides correspondent accounts
to other foreign banks and, if so, the identity of those foreign banks
and related due diligence information.
Under the USA PATRIOT Act, financial institutions must establish anti-money
laundering programs. The USA PATRIOT Act sets forth minimum standards for these
programs, including:
- the development of internal policies, procedures and controls;
- the designation of a compliance officer;
- an ongoing employee training program; and
- an independent audit function to test the programs.
Pursuant to the mandate of the USA PATRIOT Act, the Secretary of the
Treasury issued regulations effective April 24, 2002 applicable to financial
institutions. Because all federally insured depository institutions are required
to have anti-money laundering programs, the regulations provide that a financial
institution which is subject to regulation by a "federal functional" is in
compliance with the regulations if it complies with the rules of its primary
federal regulator governing the establishment and maintenance of anti-money
laundering programs.
Under the authority of the USA PATRIOT Act, the Secretary of the Treasury
adopted rules on September 26, 2002 increasing the cooperation and information
sharing between financial institutions, regulators and law enforcement
authorities regarding individuals, entities and organizations engaged in, or
reasonably suspected based on credible evidence of engaging in, terrorist acts
or money laundering activities. Under the new rules, a financial institution is
required to:
- expeditiously search its records to determine whether it maintains or
has maintained accounts, or engaged in transactions with individuals
or entities, listed in a request submitted by the Financial Crimes
Enforcement Network ("FinCEN");
- notify FinCEN if an account or transaction is identified;
- designate a contact person to receive information requests;
- limit use of information provided by FinCEN to: (1) reporting to
FinCEN, (2) determining whether to establish or maintain an account or
engage in a transaction and (3) assisting the financial institution in
complying with the Bank Secrecy Act; and
- maintain adequate procedures to protect the security and
confidentiality of FinCEN requests.
Under the new rules, a financial institution may also share information
regarding individuals, entities, organizations and countries for purposes of
identifying and, where appropriate, reporting activities that it suspects may
involve possible terrorist activity or money laundering. Such
information-sharing is protected under a safe harbor if the financial
institution:
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- notifies FinCEN of its intention to share information, even when
sharing with an affiliated financial institution;
- takes reasonable steps to verify that, prior to sharing, the financial
institution or association of financial institutions with which it
intends to share information has submitted a notice to FinCEN;
- limits the use of shared information to identifying and reporting on
money laundering or terrorist activities, determining whether to
establish or maintain an account or engage in a transaction, or
assisting it in complying with the Bank Security Act; and
- maintains adequate procedures to protect the security and
confidentiality of the information.
Any financial institution complying with these rules will not be deemed to
have violated the privacy requirements discussed above.
The Secretary of the Treasury also adopted a new rule on September 26, 2002
intended to prevent money laundering and terrorist financing through
correspondent accounts maintained by U.S. financial institutions on behalf of
foreign banks. Under the new rule, financial institutions:
- are prohibited from providing correspondent accounts to foreign shell
banks;
- are required to obtain a certification from foreign banks for which
they maintain a correspondent account stating the foreign bank is not
a shell bank and that it will not permit a foreign shell bank to have
access to the U.S. account;
- must maintain records identifying the owner of the foreign bank for
which they may maintain a correspondent account and its agent in the
Unites States designated to accept services of legal process;
- must terminate correspondent accounts of foreign banks that fail to
comply with or fail to contest a lawful request of the Secretary of
the Treasury or the Attorney General of the United States, after being
notified by the Secretary or Attorney General.
The new rule applies to correspondent accounts established after October
28, 2002.
PROPOSED LEGISLATION AND REGULATORY ACTION
New regulations and statutes are regularly proposed that contain
wide-ranging proposals for altering the structures, regulations and competitive
relationships of financial institutions operating and doing business in the
United States. We cannot predict whether or in what form any proposed regulation
or statute will be adopted or the extent to which our business may be affected
by any new regulation or statute.
EFFECT OF GOVERNMENTAL MONETARY POLICES
Our earnings are affected by domestic economic conditions and the monetary
and fiscal policies of the United States government and its agencies. The
Federal Reserve Bank's monetary policies have had, and are likely to continue to
have, an important impact on the operating results of commercial banks through
its power to implement national monetary policy in order, among other things, to
curb inflation or combat a recession. The monetary policies of the Federal
Reserve affect the levels of bank loans, investments and deposits through its
control over the issuance of United States government securities, its regulation
of the discount rate applicable to member banks and its influence over reserve
requirements to which member banks are subject. We cannot predict the nature or
impact of future changes in monetary and fiscal policies.
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ITEM 2. PROPERTIES
During 2002, we conducted our business primarily through our office located
at 817 Broad Street, Chattanooga, Hamilton County, Tennessee. This space
contains approximately 4,500 square feet and is leased until February 28, 2003.
This lease has three successive one-year renewal options. We renewed the lease
for one year until February 28, 2004 and are currently in the process of
evaluating the facilities' ability to meet our anticipated space requirements.
Frontier Bank's main office, also located at 817 Broad Street in
Chattanooga, is part of the same lease as First Security's. The main office
contains approximately 8,500 square feet of finished space used for offices,
operations and storage, four teller windows, and the Bank lobby. The facility
also has an automated teller machine with 24-hour access. Frontier Bank's main
office facility opened for business on June 26, 2000 and is in good condition.
In addition, Frontier Bank operates six full service branches in the
Chattanooga area. The first branch opened on July 3, 2000, is approximately
3,400 square feet, and is located at 1740 Gunbarrel Road, Chattanooga, Hamilton
County, Tennessee with a lease that expires on May 24, 2010. This lease has two
additional and successive five-year renewal options, as well as options to
purchase the facility in the fifth and tenth years of the original lease. The
next branch opened on July 28, 2000, is also approximately 3,400 square feet,
and is located at 4227 Ringgold Road, Chattanooga, Hamilton County, Tennessee
with a lease that expires on July 20, 2010. This lease has two successive
five-year renewal options, as well as options to purchase the facility in the
fifth and tenth years of the original lease. On May 7, 2001 Frontier Bank opened
a branch with approximately 3,400 square feet, located at 4535 Highway 58,
Chattanooga, Hamilton County, Tennessee. Frontier Bank owns the property and
building at the Highway 58 location. The next branch opened on May 29, 2001, is
approximately 2,500 square feet, and is located at 820 Ridgeway Avenue, Signal
Mountain, Hamilton County, Tennessee with a lease that expires on December 31,
2010. This lease had an option to purchase the facility in January 2003, which
we exercised. On October 22, 2001 Frontier bank opened a branch with
approximately 1,000 square feet, located at 1409 Cowart Street, Chattanooga,
Hamilton County, Tennessee with a land lease that expires on December 31, 2010.
This lease has two successive five-year renewal options. Frontier Bank owns the
building at the Cowart Street location; additionally, this location serves as
the drive-thru for Frontier Bank's main office, as approximately five city
blocks separate the two locations. On July 8, 2002 Frontier Bank opened a branch
located at 9217 Lee Highway, Ooltewah, Hamilton County, Tennessee. This branch
is owned and is approximately 3,400 square feet.
In Sweetwater, Monroe County, Tennessee, Frontier Bank owns its branch,
which is approximately 3,000 square feet. This branch, which opened for business
on June 26, 2000, is located at 761 New Highway 68 and conducts business with
the trade name First Security Bank. On November 6, 2000, Frontier Bank opened a
branch at 835 South Congress Parkway, Athens, McMinn County, Tennessee. This
location, which is owned by Frontier Bank, is approximately 1,400 square feet
and conducts business under the trade name First Security Bank. On February 5,
2001, Frontier Bank opened a loan production office with approximately 1,000
square feet located at 702 Grove Street, Suite 100, Loudon, Loudon County,
Tennessee with a lease that expired on December 31, 2001 and is now a
month-to-month lease. Recently, Frontier Bank received regulatory permission to
open and own a full-service branch to be located at 2270 Highway 72 N, Loudon,
Loudon County, Tennessee and plans to conduct business under the trade name
First Security Bank. Upon opening this branch, Frontier Bank anticipates that it
will close the Loudon loan production office. On July 2, 2001, Frontier Bank
opened a loan production office with approximately 3,200 square feet located at
119 Broadway West, Lenoir City, Loudon County, Tennessee with a lease that
expires on July 31, 2002. This lease has two successive six-month renewal
options, which were exercised. On October 15, 2002, the Lenoir City loan
production office was converted into a full-service branch operating with the
trade name First Security Bank. Frontier Bank received regulatory permission to
relocate this branch to 705 East Broadway, Lenoir City, Loudon County,
Tennessee, and plans to own the facility to be built on the site.
Dalton Whitfield Bank's main office opened on September 17, 1999 and is
located at 401 South Thornton Avenue, Dalton, Whitfield County, Georgia. The
main office contains approximately 16,500 square
16
feet of finished space used for offices, operations and storage, five teller
windows, and the Bank lobby. The facility also has a detached drive-thru and a
detached facility for mortgage operations. The main office facility is owned by
Dalton Whitfield Bank and is in good condition. Also on September 17, 1999,
Dalton Whitfield Bank opened a branch facility located at 1237 Cleveland Road,
Dalton, Whitfield County, Georgia. This branch is approximately 3,300 square
feet and is in good condition. Both the Thornton Avenue and the Cleveland Road
branches were acquired by Dalton Whitfield Bank when it purchased selected
assets and assumed most of the liabilities of Colonial Bank's three Dalton,
Georgia branches. The third branch purchased, an in-store grocery store branch,
from Colonial Bank was subsequently closed when the grocery store, Winn-Dixie,
closed the grocery store in an large down-sizing effort. On June 4, 2001, Dalton
Whitfield Bank opened a branch with approximately 2,400 square feet at 2709
Chattanooga Road, Suite 5, Rocky Face, Whitfield County, Georgia with a lease
that expires on September 30, 2005. This lease has a five-year renewal option.
Recently, Dalton Whitfield Bank received regulatory approval to open and own a
branch to be located at 35 Poplar Springs Road, Ringgold, Catoosa County,
Georgia. This 3,400 square foot branch is currently under construction and will
operate under the trade name Catoosa County Bank.
First State Bank's main office is located at 2905 Maynardville Highway,
Maynardville, Union County, Tennessee. The main office contains approximately
12,197 square feet of finished space used for offices, operations and storage,
five teller windows, a drive-thru and Bank lobby. The main office was originally
built in 1996; although First Security acquired it on July 20, 2002. The
facility is in good condition. The facility and land are owned. In order to
purchase the land, on January 5, 1995, First State Bank entered a 240-month
mortgage, which matures on January 5, 2015. Additionally, First State Bank
operates one other branch in Union County, Tennessee. The branch contains
approximately 2,000 square feet, is located at 216 Maynardville Highway,
Maynardville, Union County, Tennessee with a ten-year lease that expired on
March 16, 1993. This lease had one fifteen-year renewal option, which was
exercised. In 1999, the State of Tennessee advised First State Bank that this
branch was in the path of the future project to widen Highway 33. As a result,
First State Bank purchased a vacant lot in close proximity so that it may
relocate this branch. To date, the highway widening project has not begun and
neither has construction on a replacement branch.
In Jefferson City, Jefferson County, Tennessee, First State Bank owns a
branch with approximately 1,860 square feet. This branch, which opened for
business on November 26, 2002, is located at 167 West Broadway Boulevard and
conducts business with the trade name FSGBank. Prior to this branch, First State
Bank opened a 250 square foot, loan production office at 104 West Old AJ
Highway, Suite A, Jefferson City, Jefferson County, Tennessee. This temporary
facility was leased on a month-to-month basis and open from August 14, 2002 to
November 25, 2002, when the aforementioned Jefferson City branch opened. On
January 6, 2002, First State Bank opened a 200 square foot, loan production
office located at 1232 Gay Street, Dandridge, Jefferson County, Tennessee with a
month-to-month lease. Recently, First State Bank received regulatory approval to
open and own a branch at 1020 South Highway 92, Dandridge, Jefferson County,
Tennessee to operate under the trade name FSGBank. Upon completion of this
branch, management anticipates closing the 1232 Gay Street loan production
office.
On August 14, 2002, First State Bank opened a month-to-month leased
facility, loan production office at 318 Erin Drive, Suite 9, Knoxville, Knox
County, Tennessee which was 400 square feet. On October 1, 2002, this loan
production office relocated to Suite 8, which was approximately 1,000 square
feet and located at the same street address. Recently, First State Bank received
regulatory approval to open a branch in the Meridian Trust building located at
109 Northshore Drive, Suites 100 and 300, Knoxville, Knox County, Tennessee. The
lease on Suite 300 expires on March 1, 2008 and has four additional and
successive three-year renewal options. Assuming the lease on Suite 100 commences
on May 1, 2003, it will expire on July 1, 2006; this lease also has four
additional and successive three-year renewal options. Generally speaking,
deposit operations will be conducted in Suite 100, which is approximately 550
square feet, and loan production will occur in Suite 300, which is approximately
4,282 square feet. On March 14, 2003, we occupied Suite 300 and as a result
closed the loan production office located at 318 Erin Drive, Suite 8. Management
anticipates that Suite 100 will open in the second quarter. Both Suites 100 and
300 will conduct business under the trade name FSGBank.
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As of December 31, 2002, First Security and its subsidiaries owned five
plots of land that were either vacant or were under construction to build a
branch. The vacant lots are located in Sweetwater, Monroe County, Tennessee;
Loudon, Loudon County, Tennessee; Lenoir City, Loudon County, Tennessee;
Maynardville, Union County, Tennessee; Dandridge, Jefferson County, Tennessee;
and, Ringgold, Catoosa County, Georgia. The intent for each of these properties
is to build banking facilities, except for the Sweetwater property. The
Sweetwater vacant lot was purchased prior to the negotiations and subsequent
acquisition of First Central Bank of Monroe County. The Sweetwater vacant lot is
currently for sale, as we no longer intend to build on the site.
ITEM 3. LEGAL PROCEEDINGS
While First Security and our Banks are from time to time parties to various
legal proceedings arising in the ordinary course of their business, management
believes after consultation with legal counsel that there are no proceedings
threatened or pending against First Security or the Banks that will,
individually or in the aggregate, have a material adverse affect on the business
or consolidated financial condition of First Security.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year ended
December 31, 2002 to a vote of shareholders of First Security, through the
solicitation of profits or otherwise.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
No active public trading market exists for our common stock, and we have no
reason to believe that an active trading market will develop in the foreseeable
future. There are no present plans for our common stock to be listed or
qualified for trading on any stock exchange or with Nasdaq. As of December 31,
2002, there were approximately 1,226 holders of record of First Security's
common stock, and approximately 7,579,104 shares of common stock were issued and
outstanding. We file periodic financial and other reports with the Securities
and Exchange Commission.
The last selling price of our common stock based on information available
to us was $10.00 per share on January 31, 2003. Our shares are infrequently
traded in private transactions, and such trades are not necessarily indicative
of the value of such shares. We have not issued any options to purchase our
common stock other than to our officers and employees pursuant to the Second
Amended and Restated 1999 Long Term Incentive Plan. No options to purchase our
common stock have been issued from the 2002 Long Term Incentive Plan.
Non-executive director restricted stock grants have been issued from the 2002
Long Term Incentive Plan.
One of the chartering conditions placed upon Dalton Whitfield Bank by its
regulators, as with all newly chartered banks, was that Dalton Whitfield Bank
could not pay dividends within its first three years of operations, which
commenced on September 16, 1999, without prior regulatory approval. Now that the
three year restriction has passed, cash dividends on Dalton Whitfield Bank's
common stock may be declared and paid only out of its retained earnings, and
dividends may not be declared at any time at which Dalton Whitfield Bank's
paid-in capital and retained earnings do not, in combination, equal at least 20%
of its capital stock account. In addition, the Georgia Department of Banking and
Finance's current rules and regulations require prior approval before cash
dividends may be declared and paid if: (i) the Bank's ratio of equity capital to
adjusted total assets is less than 6%; (ii) the aggregate amount of dividends
declared or anticipated to be declared in that calendar year exceeds 50% of the
Bank's net profits, after taxes but before dividends, for the previous calendar
year; or (iii) the percentage of the Bank's loans classified as adverse as to
repayment or recovery by the Georgia Department at the most recent regulatory
examination of the Bank exceeds 80% of the Bank's equity capital as reflected at
such examination.
Similarly, Frontier Bank is not allowed to pay dividends in its first three
years of operations with such operations commencing on June 26, 2000. After the
three year restriction has passed, cash dividends on Frontier Bank's common
stock may be declared and paid only out of its retained earnings, and net
profits may be credited to retained earnings only after the proper deductions
have been made for all expenditures, expenses, taxes, losses, bad debts, and any
write-offs or other deductions as required by the Commissioner of the Tennessee
Department of Financial Institutions. Thereafter, Frontier Bank may declare and
pay dividends from that account in an amount determined appropriate by its board
of directors. Before declaring the dividend, however, the board of directors
must deduct any net loss from the undivided profits account and transfer to the
Bank's surplus account: (i) the amount, if any, required to raise the surplus to
50% of the capital stock; and (ii) the amount required, if any, but not less
than 10% of net profits, to make the paid-in surplus account equal the capital
stock account. After these requirements are met, Frontier Bank may declare a
dividend if it is adequately reserved against deposits and those reserves will
not be impaired by the declaration of the dividend.
First State Bank is not subject to any chartering limitations that restrict
its ability to pay dividends to First Security.
We have never paid any cash dividends on our common stock, and we do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to support the development and growth
of our business. Payment of future dividends, if any, will be at the discretion
of our
19
board of directors and will depend upon our earnings, our financial condition,
the capital adequacy of First Security and our subsidiaries, opportunities for
growth and expansion, our subsidiaries' need for funds, and other relevant
factors, including applicable restrictions and governmental policies and
regulations.
Our sources of income, other than investments held by us, and fees paid to
us by our subsidiary Banks, are limited to dividends we may receive from Dalton
Whitfield Bank, Frontier Bank, or First State Bank. Our subsidiaries' ability to
pay dividends is subject to statutory and regulatory restrictions on the payment
of cash dividends applicable to the Banks, and our need to maintain adequate
capital in our Bank subsidiaries and in our holding company.
In 2002, the Company sold and issued the following unregistered securities:
1. On March 19, 2002, First Security's non-underwritten private placement
of up to $20 million in shares of First Security's common stock at a price of
$10 per share became effective. Subsequently, the private placement was
increased from $20 million to $25 million and then again to $27.5 million. The
private placement closed on August 8, 2002, by which time First Security had
sold 2,576,460 shares in the offering to 422 investors who all represented that
they were accredited investors. The proceeds from this offering were used to
acquire First State Bank and have been and will be used to support growth
opportunities for First Security and its subsidiaries. We relied upon Rule 506
of regulation D of the Securities Act of 1933 to exempt this transaction from
registration under the federal securities laws.
2. On March 26, 2002 we granted incentive stock options to purchase an
aggregate of 3,000 shares of our common stock at an exercise price of $10.00 to
an employee under the Second Amended and Restated 1999 Long-Term Incentive Plan.
None of these options has been exercised, and none has been cancelled. In
granting these incentive stock options to our employee, we relied upon the
exemptions under Sections 3(a)(11) and/or 4(2) to exempt the transactions from
registration under the federal securities laws.
3. On October 24, 2002 we granted incentive stock options to purchase an
aggregate of 128,000 shares of our common stock at an exercise price of $10.00
to our employees under the Second Amended and Restated 1999 Long-Term Incentive
Plan. None of these options has been exercised, and none has been cancelled. In
granting these incentive stock options to our employees, we relied upon the
exemptions under Sections 3(a)(11) and/or 4(2) to exempt the transactions from
registration under the federal securities laws.
No underwriters were involved in the foregoing sales of securities. The
recipients of securities in each transaction represented their intentions to
acquire the securities for investment only and not with a view to or for sale in
connection with any distribution of the securities, and appropriate legends were
affixed to the share certificates and options issued in such transactions.
Similar representations of investment intent were obtained and similar legends
imposed in connection with any subsequent transfers of such securities. We
believe that all recipients had adequate access, through employment or other
relationships, to information about us to make an informed investment decision.
20
ITEM 6. SELECTED FINANCIAL DATA
The data presented below is derived from the consolidated financial
statements of First Security and from Colonial Bank. Dalton Whitfield Bank
purchased certain assets and assumed certain liabilities when it acquired
Colonial Bank's three Dalton, Georgia branches in September 1999. The financial
statements of the three purchased Colonial Bank branches in Dalton, Georgia and
of First Security have been audited by Joseph Decosimo and Company, LLP. The
financial statements of the purchased Colonial Bank branches and the
consolidated financial statements of First Security are included in another part
of this Annual Report. You should read the selected consolidated financial data
together with these historical financial statements and the "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
data shown under "Colonial Bank Branches" includes banking operations conducted
by Colonial Bank in Dalton, Georgia prior to our acquisition of these three
branches in September 1999.
SELECTED CONSOLIDATED FINANCIAL DATA
FIRST SECURITY
--------------------------------------------------------------
FISCAL YEAR FISCAL YEAR FISCAL YEAR FOUR MONTHS
ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000 1999
-------------- -------------- -------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Gross interest income $ 25,621 $ 20,793 $ 11,824 $ 2,348
Gross interest expense 8,417 9,783 5,510 812
-------------- -------------- -------------- --------------
Net interest income 17,204 11,010 6,314 1,536
Provision for loan losses 1,948 2,496 811 -
-------------- -------------- -------------- --------------
Net interest income
after provision 15,256 8,514 5,503 1,536
Noninterest income 3,819 2,743 1,088 176
Noninterest expense 14,915 11,004 7,504 2,542
-------------- -------------- -------------- --------------
Pretax income (loss) 4,160 253 (913) (830)
Income tax expense (benefit) 1,558 235 (347) (315)
-------------- -------------- -------------- --------------
Net income (loss) $ 2,602 $ 18 $ (566) $ (515)
============== ============== ============== ==============
PER COMMON SHARE:
Basic earnings (loss) $ 0.40 $ 0.00 $ (0.14) $ (0.13)
Diluted earnings (loss) $ 0.39 $ 0.00 $ (0.14) $ (0.13)
Cash dividends declared $ - $ - $ - $ -
Book value (shareholders' equity) $ 8.96 $ 7.85 $ 7.45 $ 7.55
AT PERIOD END:
Loans $ 348,582 $ 291,043 $ 152,913 $ 69,724
Earning assets 436,774 328,330 177,461 92,843
Total assets 472,924 361,866 199,552 110,511
Deposits 384,483 293,877 162,514 74,885
Shareholders' equity 67,933 39,265 30,594 31,016
Shares outstanding - basic 7,579 5,003 4,106 4,106
Shares outstanding - diluted 7,659 5,085 4,106 4,106
AVERAGE BALANCES:
Loans $ 311,774 $ 221,624 $ 107,483 $ 48,439
Earning assets 384,483 254,739 132,377 80,186
Total assets 415,810 279,377 150,308 96,028
Deposits 337,198 233,007 114,239 61,673
Shareholders' equity 56,039 33,292 30,754 30,822
Shares outstanding - basic 6,538 4,354 4,106 4,106
Shares outstanding - diluted 6,620 4,429 4,106 4,106
KEY RATIOS:
Return on average assets 0.63% 0.01% -0.38% -0.54%
Return on average shareholders' equity 4.64% 0.05% -1.84% -1.67%
Net interest margin, taxable equivalent 4.53% 4.32% 4.77% 4.56%
Efficiency ratio (2) 70.95% 76.50% 101.40% 148.50%
Dividend payout ratio 0.00% 0.00% 0.00% 0.00%
Average equity to average assets 13.48% 11.92% 15.30% 28.10%
Nonperforming assets to total assets 0.16% 0.17% 0.06% 0.23%
Nonperforming assets to loan loss reserve (3) 14.10% 15.77% 5.66% 24.12%
21
COLONIAL BANK BRANCHES
------------------------------
EIGHT MONTHS FISCAL YEAR
ENDED ENDED
AUGUST 31, DECEMBER 31,
1999 1998
-------------- --------------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Gross interest income $ 4,365 $ 7,216
Gross interest expense 1,987 3,363
-------------- --------------
Net interest income 2,378 3,853
Provision for loan losses 280 300
-------------- --------------
Net interest income
after provision 2,098 3,553
Noninterest income 541 956
Noninterest expense 1,905 3,401
-------------- --------------
Pretax income (loss) 734 1,108
Income tax expense (benefit) 279 421
-------------- --------------
Net income (loss) $ 455 $ 687
============== ==============
PER COMMON SHARE:
Basic earnings (loss) N / A N / A
Diluted earnings (loss) N / A N / A
Cash dividends declared N / A N / A
Book value (shareholders' equity) N / A N / A
AT PERIOD END:
Loans $ 61,502 $ 70,805
Earning assets 94,874 78,324
Total assets 108,193 94,184
Deposits 91,791 74,826
Shareholders' equity 14,046 13,591
Shares outstanding - basic N / A N / A
Shares outstanding - diluted N / A N / A
AVERAGE BALANCES:
Loans $ 67,064 $ 66,917
Earning assets 80,944 84,133
Total assets 101,161 (1) 100,058
Deposits 78,132 79,814
Shareholders' equity 13,819 (1) 13,248
Shares outstanding - basic N / A N / A
Shares outstanding - diluted N / A N / A
KEY RATIOS:
Return on average assets 0.45% 0.69%
Return on average shareholders' equity 3.29% 5.19%
Net interest margin, taxable equivalent 4.41% 4.58%
Efficiency ratio (2) 65.30% 70.70%
Dividend payout ratio N / A N / A
Average equity to average assets 13.70% 13.20%
Nonperforming assets to total assets 0.09% 0.79%
Nonperforming assets to loan loss reserve (3) 7.67% 63.47%
_______________
1 Average computed by adding end of period for current year and prior year
and dividing by two.
2 Noninterest Expense divided by the sum of Net Interest Income and
Noninterest Income.
3 Colonial Bank did not separately allocate these to the three Dalton
Branches.
22
PRO FORMA STATEMENT OF OPERATIONS FOR 1999
The following unaudited pro forma statement of operations for the year
ended December 31, 1999 has been derived from the audited financial statements
of the three Colonial Bank branches in Dalton, Georgia for the eight months
ended August 31, 1999 and the audited financial statements of First Security for
the four months ended December 31, 1999. The following unaudited pro forma
statement of operations has also been adjusted to give effect to First
Security's purchase of Colonial Bank's three Dalton, Georgia branches as if this
acquisition had occurred on January 1, 1999. This branch purchase was accounted
for using the purchase method of accounting. The pro forma information included
in this Annual Report does not purport to represent what First Security's
results of operations would actually have been had the branch purchase occurred
on January 1, 1999. The pro forma statement of operations should be read in
conjunction with the statement of operations of the three purchased Colonial
Bank branches for the eight months ended August 31, 1999 and First Security's
statement of operations data for the four months ended December 31, 1999, both
of which are included elsewhere in this Annual Report and have been audited by
Joseph Decosimo and Company, LLP, independent public accountants.
COLONIAL
BANK
BRANCHES FIRST SECURITY
(8 MONTHS) (4 MONTHS) COMBINED ADJUSTMENTS PRO FORMA
----------- ---------------- ------------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Interest income. . . . . . . . . . . $ 4,365 $ 2,348 $ 6,713 $ (315)(1) $ 6,398
Interest expense . . . . . . . . . . 1,987 812 2,799 315 (1) 2,484
----------- ---------------- ------------- ----------- ----------
Net interest income. . . . . . . . . 2,378 1,536 3,914 0 3,914
Provision for loan losses. . . . . . 280 0 280 0 280
----------- ---------------- ------------- ----------- ----------
Net interest income after provision. 2,098 1,536 3,634 0 3,634
Noninterest income . . . . . . . . . 541 176 717 0 717
Noninterest expense. . . . . . . . . 1,905 2,542 4,447 319(2) 4,766
----------- ---------------- ------------- ----------- ----------
Pretax income (loss) . . . . . . . . 734 (830) (96) (319) (415)
Income tax expense (benefit) . . . . 279 (315) (36) (121) (157)
----------- ---------------- ------------- ----------- ----------
Net income (loss). . . . . . . . . . $ 455 $ (515) $ (60) $ (198) $ (258)
=========== ================ ============= =========== ==========
PER COMMON SHARE(3)
Basic earnings (loss). . . . . . . . -- (0.13) -- (0.22)(3)
Diluted earning (loss) . . . . . . . -- (0.13) -- (0.22)(3)
Cash dividends declared. . . . . . . -- 0.00 -- N/A
(Book value) . . . . . . . . . . . . -- 7.55 -- N/A
1 Reflects the elimination of interest income earned by First Security on its
deposit with Colonial Bank during the eight month period ended August 31,
1999.
2 Reflects a full year effect of depreciation associated with the write-up of
the fair market value of the assets acquired in First Security's purchase
of Colonial Bank's three Dalton, Georgia branches and amortization expense
related to the goodwill associated with this branch purchase.
3 Based on 1,197,583 weighted average shares outstanding for the year.
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our financial statements and notes included in
this Annual Report on Form 10-K. The discussion in the Annual Report on Form
10-K contains forward-looking statements that involve risks and uncertainties,
such as our plans, objectives, expectations, and intentions. The cautionary
statements made in this Annual Report on Form 10-K should be read as applying to
all related forward-looking statements wherever they appear in this Annual
Report. Our actual results could differ materially from those discussed in this
Annual Report on Form 10-K.
All per share data has been retroactively adjusted for the 13 for 10 stock
split in the form of a stock dividend effected on April 15, 2001.
YEAR ENDED DECEMBER 31, 2002
The following discussion and analysis sets forth the major factors that
affected First Security's financial condition as of December 31, 2002 and 2001,
and results of operations for the three years ended December 31, 2002 as
reflected in the audited financial statements.
OVERVIEW
As of December 31, 2002, First Security had total consolidated assets of
$472.9 million, total loans of $348.6 million, total deposits of $384.5 million,
and shareholders' equity of $67.9 million. In 2002, our net income was $2.6
million while basic and diluted net income per basic and diluted common share
were $0.40 and $0.39, respectively.
We are uncertain how the war on terrorism, and more specifically the United
States led war on Iraq, may affect our business. The general economic slowdown
coupled with uncertainty associated with war may have delayed effects that may
adversely affect both our commercial banking and mortgage banking business.
Additionally, under the Soldiers' and Sailors' Civil Relief Act of 1940, a
borrower who enters military service is afforded various types of relief under
their loans and other obligations, including a maximum annual interest rate of
6% during the period of the borrower's active duty. We cannot predict the effect
that the Relief Act will have on our loan portfolio.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of First Security and its
subsidiaries are in accordance with accounting principles generally accepted in
the United States of America and conform to general practices within the banking
industry. First Security's significant accounting policies are discussed in
detail in Note 1 in the "Notes to Consolidated Financial Statements." Critical
accounting policies include the initial adoption of an accounting policy that
has a material impact of its financial presentation and accounting estimates
reflected in its financial statements that require First Security to make
assumptions about matters that were highly uncertain at the time of estimation.
Disclosure about critical estimates is required if different estimates that
First Security reasonably could have used in the current period, would have a
material impact on the presentation of First Security's financial condition,
changes in financial condition or results of operations. Accounting policies
related to the allowance for loan losses represent a critical accounting
estimate.
The allowance for loan losses is established and maintained at levels
management deems adequate to cover probable losses inherent in the portfolio as
of the balance sheet date. The level is based on past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, underlying estimated values of collateral
securing loans, current economic conditions and other factors. Should any of
these factors change, the estimate of credit losses in the loan portfolio and
the related allowance would also change.
24
RESULTS OF OPERATIONS
First Security reported net income for 2002 of $2.6 million versus net
income for 2001 of $18 thousand. The net loss for 2000 was $566 thousand. In
2001, basic and diluted net income per share was $0.40 and $0.39, respectively,
on 6,538,215 and 6,619,814 weighted average basic and diluted, shares
outstanding, respectively. In 2001, basic and diluted net income per share was
$0.00 on 4,353,580 and 4,428,266 weighted average basic and diluted shares
outstanding, respectively. For 2000, we had a net loss per share of $0.14 on
4,106,350 weighted average basic and diluted shares outstanding. First
Security's improvement from a net loss to net income resulted from growth and
the addition of earning assets, as well as the adoption of SFAS 142.
Through the adoption of SFAS 142, goodwill amortization expense was not
incurred after 2001; however, the goodwill will be written down should the
carrying value become impaired. In 2002, management determined that the carrying
value of First Security's goodwill had not been impaired, and as a result, no
write down expenses were incurred. For comparative purposes, net income per
average share (basic and diluted), without amortization of goodwill (net of tax
benefit), for 2001 would have been $0.07 and the net loss per average share in
2000 would have been $0.07.
We believe that our net income will continue to improve in 2003 as a result
of our pending acquisition of Premier National Bank of Dalton, as well as our
anticipated growth through branching and marketing efforts.
The following table summarizes the components of income and expense and the
changes in those components for the past three years.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------
CHANGE CHANGE CHANGE
FROM PRIOR FROM PRIOR FROM PRIOR
2002 YEAR % 2001 YEAR % 2000 YEAR %
-------------------------------- ------------------------------ -------------------------------
(Dollar amounts in thousands)
Interest income $25,621 $ 4,828 23.22% $20,793 $ 8,969 75.85% $11,824 $ 5,426 84.81%
Interest expense 8,417 (1,366) -13.96% 9,783 4,273 77.55% 5,510 3,026 121.82%
-------------------------------- ------------------------------ -------------------------------
Net interest income 17,204 6,194 56.26% 11,010 4,696 74.37% 6,314 2,400 61.32%
Provision for loan losses 1,948 (548) -21.96% 2,496 1,685 207.77% 811 531 189.64%
-------------------------------- ------------------------------ -------------------------------
Net interest income after
provision for loan losses 15,256 6,742 79.19% 8,514 3,011 54.72% 5,503 1,869 51.43%
Noninterest income 3,819 1,076 39.23% 2,743 1,655 152.11% 1,088 371 51.74%
Noninterest expense 14,915 3,911 35.54% 11,004 3,500 46.64% 7,504 2,738 57.45%
-------------------------------- ------------------------------ -------------------------------
Income before income taxes 4,160 3,907 1544.27% 253 1,166 -127.71% (913) (498) 120.00%
Income tax expense (benefit) 1,558 1,323 562.98% 235 582 -167.72% (347) (190) 121.02%
-------------------------------- ------------------------------ -------------------------------
Net income (loss) $ 2,602 $ 2,584 14355.56% $ 18 $ 584 -103.18% $ (566) $ (308) 119.38%
================================ ============================== ===============================
Further explanation, with year-to-year comparisons of the income and
expense, is provided below.
NET INTEREST INCOME
Net interest income (the difference between the interest earned on assets,
such as loans and investment securities, and the interest paid on liabilities,
such as deposits and other borrowings) is our primary source of operating
income. In 2002, net interest income was $17.2 million or 56% more than the 2001
level of $11 million, which in turn was 74% more than the 2000 level of $6.3
million.
25
First Security monitors and evaluates the effects of certain risks on its
earnings and seeks balance between the risks assumed and the returns sought.
Some of these risks include interest rate risk, credit risk, and liquidity risk.
The level of net interest income is determined primarily by the average
balances (volume) of interest-earning assets and the various rate spreads
between our interest-earning assets and our funding sources. Changes in net
interest income from period to period result from increases or decreases in the
volume of interest-earning assets and interest-bearing liabilities, increases or
decreases in the average interest rates earned and paid on such assets and
liabilities, the ability to manage the interest-earning asset portfolio (which
includes loans), and the availability of particular sources of funds, such as
noninterest-bearing deposits.
Interest income in 2002 was $25.6 million, or a 23% increase over the 2001
level of $20.8 million, which was 76% more than the $11.8 million earned in
2000. Year-to-year increases from 2000 to 2001 to 2002 were due to the annual
increases in the volume of earning assets. Average earning assets in 2002 were
$384.5 million, an increase of $129.7 million or 51% from 2001 average earning
assets. In 2002, our earning assets increased due to (i) the deposit gathering
activities of our Banks - deposits raised were used to fund or acquire earning
assets, (ii) the acquisition of First State Bank - which had approximately $48
million in earning assets on the acquisition date, July 20, 2002, and (iii) the
non-underwritten private placement of First Security's common stock - the
proceeds from which were used to fund or acquire earning assets. These
additional earning assets have enabled First Security to earn more interest
income. Counteracting the additional earnings from increased volumes were the
decreases in yields on earnings assets. The tax equivalent yield on earning
assets decreased in 2002 to 6.72% from 8.16% in 2001 (or 144 basis points);
similarly, the yield on earning assets decreased in 2001 by 77 basis points from
the 2000 level of 8.93%. The decrease in yield was due to the Federal Reserve
decreasing the federal funds rate and the discount rate 11 times in 2001 and one
time in 2002, which caused reductions in the prime-lending rate. The decline in
yield on earning assets from 2001 to 2002 outpaced the decline in yield from
2000 to 2001 due to re-pricing time lags of our loans and investment securities.
Due to general economic weakness, as well as the loans and investment securities
which continue to re-price at current interest rates, we anticipate that
interest rates on earning assets may continue to decline in 2003.
Total interest expense was $8.4 million in 2002 compared to $9.8 million in
2001, or 14% lower. Unlike interest income, interest expense decreased because
the impact of lower rates paid on deposits exceeded the increase in interest
expense resulting from the additional volume of interest bearing liabilities.
Average interest-bearing liabilities increased $93.3 million or 45% from 2001 to
2002. Similarly, the increase from 2000 to 2001 was $104.8 million or 104%. As
with interest income, the increase in 2002 is due to (i) our Banks' market
penetration and (ii) our acquisition of First State Bank. The average rate paid
on average interest-bearing liabilities decreased 194 basis points from 4.75% in
2001 to 2.81% in 2002. In 2001, the rate paid was 81 basis points lower than the
2000 level of 5.56%. The rate decreases in 2002 and 2001 resulted from the
previously discussed Federal Reserve policy changes. We believe that interest
rates may continue to decrease on interest-bearing liabilities, absent any
competitive pricing pressures.
The banking industry uses two key ratios to measure relative profitability
of net interest income: net interest rate spread and net interest margin. The
net interest rate spread measures the difference between the average yield on
earning assets and the average rate paid on interest-bearing liabilities. The
net interest rate spread does not consider the impact of noninterest-bearing
deposits and gives a direct perspective on the effect of market interest rate
movements. The net interest margin is defined as net interest income as a
percentage of total average earning assets and takes into account the positive
effects of investing noninterest-bearing deposits in earning assets.
First Security's net interest rate spread (on a tax equivalent basis) was
3.91% in 2002, 3.41% in 2001, and 3.47% in 2000, while the net interest margin
(on a tax equivalent basis) was 4.53% in 2002, 4.32% in 2001, and 4.77% in 2000.
The increased net interest margin from 2001 to 2002 was due to (i) interest
bearing sources of funding comprising a smaller percentage of overall funding in
2002 than in 2001, and (ii) the Federal Reserve rate decreases resulting in our
yield on our interest earning assets declining at a slower pace
26
than the decline in the rate on our interest bearing liabilities. Average
interest bearing liabilities as a percentage of average earning assets was 78%
in 2002 compared to 81% in 2001 and 76% in 2000. Even though our analysis shows
that our balance sheet is asset sensitive (see Management's Discussion and
Analysis of Financial Condition and Results of Operation - Interest Rate
Sensitivity), we managed to improve our net interest spread and net interest
margin on a tax equivalent basis by actively monitoring and repricing our
liability rates, as well as using rate floors on loans and investment tax
strategies.
Interest rate decreases in 2001 resulted from the Federal Reserve's
initiative to stimulate economic growth in the weakening U.S. economy. In 2001
the Federal Reserve cut interest rates 11 times for an aggregate total of 4.75%.
At the beginning of 2001, the federal funds rate and the prime lending rate were
6.5% and 9.5%, respectively. By the end of 2001, these rates had decreased to
1.75% and 4.75%. On November 6, 2002, the Federal Reserve dropped interest rates
0.5%, which effectively decreased the federal funds rate and the prime lending
rate to 1.25% and 4.25%, respectively. Otherwise, the Federal Reserve has not
increased or decreased interest rates during 2002, or thus far in 2003.
Since year-end 2002, economic indicators remain generally weak. As a
result, we anticipate that the Federal Reserve may decrease interest rates in
2003. Based on the federal funds futures, and based on Federal Reserve Chairman
Alan Greenspan's recent comments, we believe interest rate decreases will likely
be small and infrequent. We believe that our net interest margin, inclusive of
competitive pricing pressures, may decrease in 2003.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS
FULLY TAX-EQUIVALENT BASIS
The following tables show the relative impact on net interest income of
changes in the average outstanding balances (volume) of earning assets and
interest-bearing liabilities and the rates earned and paid by our subsidiaries
on such assets and liabilities. Variances resulting from a combination of
changes in rate and volume are allocated in proportion to the absolute dollar
amounts of the change in each category.
27
For the Years Ended December 31,
----------------------------------------------------------
2002 2001
---------------------------- ----------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
---------------------------- ------------------------------
(Dollar amounts in thousands)
(Fully tax equivalent basis)
ASSETS
Earning assets:
Loans, net of unearned income $311,774 $ 23,144 7.42% $221,624 $ 18,886 8.52%
Investment securities 46,848 2,214 4.73% 27,079 1,635 6.04%
Other earning assets 25,861 470 1.82% 6,036 272 4.51%
------------------------------ ----------------------------
Total earning assets 384,483 25,828 6.72% 254,739 20,793 8.16%
------------------- ----------------
Allowance for loan losses (4,198) (2,818)
Intangible asset 7,202 6,437
Cash & due from banks 13,253 10,598
Premises & equipment 10,949 8,321
Other assets 4,121 2,100
--------- ---------
Total assets $415,810 $279,377
========= =========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest bearing liabilities:
NOW accounts $ 24,431 249 1.02% $ 17,469 305 1.75%
Money market accounts 68,855 1,412 2.05% 31,805 1,114 3.50%
Savings deposits 13,228 171 1.29% 7,485 189 2.53%
Time deposits < $100 106,661 3,665 3.44% 86,854 4,934 5.68%
Time deposits > $100 66,218 2,450 3.70% 51,106 2,852 5.58%
Federal funds purchased 1,277 24 1.88% 2,511 73 2.91%
Repurchase agreements 12,193 179 1.47% 7,265 246 3.39%
Other borrowings 6,165 267 4.33% 1,252 70 5.59%
------------------------------ ----------------------------
Total interest bearing liabilities 299,028 8,417 2.81% 205,747 9,783 4.75%
------------------- ----------------
Net interest spread $ 17,411 3.91% $11,010 3.41%
========= =========
Noninterest bearing demand deposits 57,805 38,288
Accrued expenses and other liabilities 2,938 2,050
Shareholders' equity 55,657 33,025
Accumulated other comp income (loss) 382 267
--------- ---------
Total liabilities and shareholders' equity $415,810 $279,377
========= =========
Impact of noninterest bearing sources
and other changes in balance sheet
composition 0.62% 0.91%
------ ------
Net interest margin 4.53% 4.32%
====== ======
For the Years Ended December 31,
-----------------------------
2000
-----------------------------
Average Income/ Yield/
Balance Expense Rate
-----------------------------
(Dollar amounts in thousands)
(Fully tax equivalent basis)
ASSETS
Earning assets:
Loans, net of unearned income $107,483 $ 10,219 9.51%
Investment securities 16,188 1,125 6.95%
Other earning assets 8,706 480 5.51%
-----------------------------
Total earning assets 132,377 11,824 8.93%
-----------------
Allowance for loan losses (1,328)
Intangible asset 6,340
Cash & due from banks 5,279
Premises & equipment 6,351
Other assets 1,289
---------
Total assets $150,308
=========
LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest bearing liabilities:
NOW accounts $ 11,963 231 1.93%
Money market accounts 9,219 413 4.48%
Savings deposits 6,474 169 2.61%
Time deposits < $100 46,861 3,003 6.41%
Time deposits > $100 22,138 1,471 6.64%
Federal funds purchased 1,352 83 6.14%
Repurchase agreements 2,722 126 4.63%
Other borrowings 213 14 6.57%
-----------------------------
Total interest bearing liabilities 100,942 5,510 5.46%
-----------------
Net interest spread $ 6,314 3.47%
=========
Noninterest bearing demand deposits 17,584
Accrued expenses and other liabilities 1,028
Shareholders' equity 30,821
Accumulated other comp income (loss) (67)
---------
Total liabilities and shareholders' equity $150,308
=========
Impact of noninterest bearing sources
and other changes in balance sheet
composition 1.30%
-------
Net interest margin 4.77%
=======
28
CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS
2002 compared to 2001 2001 compared to 2000
increase (decrease) increase (decrease)
in interest income and expense in interest income and expense
due to changes in: due to changes in:
---------------------------- ---------------------------
Volume Rate Total Volume Rate Total
---------------------------- ---------------------------
(Dollar amounts in thousands)
Earning assets:
Loans, net of unearned income $ 6,692 $(2,434) $ 4,258 $ 9,727 $(1,060) $8,667
Investment securities 934 (355) 579 658 (148) 510
Other earning assets 360 (162) 198 (120) (88) (208)
---------------------------- ---------------------------
Total earning assets 7,986 (2,951) 5,035 10,265 (1,296) 8,969
Interest bearing liabilities:
NOW accounts 71 (127) (56) 96 (22) 74
Money market accounts 760 (462) 298 791 (90) 701
Savings deposits 74 (92) (18) 26 (6) 20
Time deposits < $100 681 (1,950) (1,269) 2,272 (341) 1,931
Time deposits > $100 559 (961) (402) 1,617 (236) 1,381
Federal funds purchased (23) (26) (49) 34 (44) (10)
Repurchase agreements 72 (139) (67) 154 (34) 120
Other borrowings 213 (16) 197 58 (2) 56
---------------------------- ---------------------------
Total interest bearing liabilities 2,407 (3,773) (1,366) 5,048 (775) 4,273
---------------------------- ---------------------------
Increase (decrease) in net interest income $ 5,579 $ 822 $ 6,401 $ 5,217 $ (521) $4,696
============================ ===========================
PROVISION FOR LOAN LOSSES
The provision for loan losses charged to operations during 2002 was $1.9
million compared to $2.5 million in 2001 and $811 thousand in 2000. In 2002, net
charge-offs totaled $788 thousand, which is an increase from $613 thousand in
2001, and from $20 thousand in 2000. Net charge-offs as a percentage of average
loans were 0.25% in 2002, 0.28% for 2001, and 0.02% for 2000 and our Banks'
blended peer group averages were 0.23%, 0.24%, and 0.18% in 2002, 2001, and
2000, respectively.
In 2002 the provision was less than 2001 as a result of our analysis of
inherent risks in the loan portfolio in relation to the portfolio's growth, the
level of past due, classified, and nonperforming loans, as well as general
economic weakness. The loan portfolio increased by $57.5 million from year-end
2001 to year-end 2002, compared to an increase of $138.1 million from year-end
2000 to year-end 2001. In the fourth quarter of 2002, management increased the
reserve percentage on special mention loans from 2% to 5% due to concerns
regarding general economic weakness
We anticipate that during 2003, our provision expense for loan losses will
increase because we believe that our loan portfolio will grow at a faster pace
than it grew in 2002 as a result of our branching and marketing efforts.
The allowance for loan losses reflects management's assessment and estimate
of the risks associated with extending credit and its evaluation of the quality
of the loan portfolio. We periodically analyze our loan portfolio in an effort
to establish an allowance for loan losses that we believe will be adequate in
light of anticipated risks and loan losses. In assessing the adequacy of the
allowance, we review the size, quality and risk of loans in the portfolio. We
also, on at least a quarterly basis, consider such factors as:
29
- our Banks' loan loss experience;
- the amount of past due and nonperforming loans;
- specific known risks;
- the status and amount of past due and nonperforming assets;
- underlying estimated values of collateral securing loans;
- current economic conditions; and
- other factors which we believe affect potential credit losses.
An analysis of the credit quality of the loan portfolio and the adequacy of
the allowance for loan losses is prepared by our Banks and presented to their
respective boards of directors on a regular basis. Additionally, in 2002 we
engaged an outside loan review consultant to perform an independent review of
the quality of the loan portfolio and adequacy of the allowance. Subsequent to
year-end, we hired a Senior Credit Administration officer and a Senior Loan
Review officer to oversee First Security's Credit Administration and Loan Review
programs, respectively. The Senior Credit officer has 18 years experience in
credit administration and the Senior Loan Review officer has 33 years of field
and supervisory experience with the FDIC. Management felt it prudent to hire for
these positions due to general economic weakness and an increase in
nonperforming assets.
The Banks' allowance for loan losses is also subject to regulatory
examinations and determinations as to adequacy which may take into account such
factors as the methodology used to calculate the allowance for loan losses and
the size of the allowance for loan losses compared to a group of peer banks
identified by the regulators. During their routine examinations of banks,
federal and/or state regulators may require a bank to make additional provisions
to its allowance for loan losses when, in the opinion of the regulators, their
credit evaluations and allowance for loan loss methodology differ materially
from ours.
As of December 31, 2002, Frontier Bank's allowance for loan losses was $3.1
million (compared to $2.1 million at year end 2001), or 1.62% (1.25% for 2001)
of the year-end loans outstanding at Frontier Bank. Frontier Bank's peer group,
as defined by the Federal Financial Institutions Examination Council's December
31, 2002 Uniform Bank Performance Report, includes all insured commercial banks
between $100 million and $300 million average assets with 3 or more banking
offices located in a metropolitan area. This peer group, which includes 827
banks, had a ratio of the allowance for loan losses divided by total loans of
1.26% as of December 31, 2002, or 36 basis points less than Frontier Bank. When
Frontier Bank was chartered in 2000, the Tennessee Department of Financial
Institutions imposed a three-year charter condition that "at all times during
the first three (3) years of operation, the Bank shall maintain a minimum
allowance for loan losses ratio of 1.25 percent of total loans." We do not
believe that this requirement inflated our allowance as of December 31, 2002,
because the required allowance based on our methodology and assessment was
greater than the charter condition of 1.25%. Frontier Bank's methodology for
determining this adequacy level at December 31, 2002, is as follows:
- Special mention loans were reserved at 5% of the loan balance. In
2001, we reserved special mention loans at 2%. We felt this change to
be prudent due to the general weakness of the economy. Our loan policy
states that special mention loans shall be reserved between 1% and 5%
depending on the consideration of factors listed above on this page
30. Special mention loans are loans that must be followed closely
because of identified weaknesses, which if not checked and corrected,
could result in an unacceptable increase in credit risk. As of
December 31, 2002, Frontier Bank had $6.6 million of special mention
loans compared to $5.4 million as of December 31, 2001. These loans
may be characterized by:
Loans to Businesses:
- Downward trend in sales, profit levels and margins
- Impaired working capital position compared to industry
- Cash flow strained in order to meet debt repayment schedule
- Technical defaults due to noncompliance with financial covenants
30
- Recurring trade payable slowness
- High leverage compared to industry average with shrinking equity
cushion
- Management abilities are questionable
- Weak industry conditions
- Inadequate or outdated financial statements; if audited, adverse
opinion may be issued
Loans to Businesses or Individuals:
- Loan delinquencies and overdrafts may occur
- Original source of repayment questionable
- Documentation deficiencies may not be easily correctable
- Loan may need to be restructured
- Collateral/Guarantor offers adequate protection
- Unsecured debt to tangible net worth is excessive
- Substandard loans were reserved at 15% of the loan balance. Our loan
policy states that substandard loans shall be reserved between 10% and
20% depending on the consideration of the factors listed above on page
30. Substandard loans are loans that reflect significant deficiencies
due to severely adverse trends of a financial, economic, or managerial
nature. As of December 31, 2002, Frontier Bank had $6.8 million of
substandard loans compared to $160 thousand as of December 31, 2001.
Among the loans rated substandard at year-end 2002, Frontier Bank's
board of directors authorized six loans to be reserved at rates
outside the policy guidelines. One loan totaling $2 million was
reserved at 5% due to cash deposit reserve accounts. Five loans
totaling $2.8 million were reserved at 25%. Management is watching
these loans closely and may change the reserves if their conditions
strengthen or weaken. For substandard loans, a protracted work-out is
likely due to the following factors, in addition to those listed for
special mention loans:
Loans to Businesses:
- Sustained losses which have severely eroded equity and cash flows
- Concentration in liquid assets
- Serious management problems or internal fraud
- Chronic trade payable slowness; may be placed on COD or
collection by trade creditor
- Inability to access other funding sources
- Financial statements with adverse opinion or disclaimer; may be
received late
Loans to Businesses or Individuals:
- Chronic or severe delinquency
- Original repayment terms liberalized due to inability to meet
original terms
- Frequent overdrafts
- Likelihood of bankruptcy exists
- Serious documentation deficiencies
- Reliance on secondary sources of repayment
- Demand letter may have been sent
- Litigation may have been filed against the borrower
- Interest non-accrual may be warranted
- Collateral/Guarantor may offer inadequate protection; possibility
of loss exists
31
- Doubtful loans were reserved at 50% of the loan balance. Our loan
policy states that doubtful loans shall be reserved between 40% and
60% depending on the consideration of the factors listed above on page
30. Doubtful loans are loans where the probability of loss of
principal and/or interest is high. Positive and vigorous action is
required to minimize such loss. Doubtful loans must be placed on
non-accrual, and the principal balance charged down to estimated
collectable value, or a full or partial reserve must be allocated. As
of December 31, 2002, Frontier Bank had $3 thousand of doubtful loans
compared to $19 thousand as of December 31, 2001. In addition to the
characteristics listed for substandard loans, the following
characteristics apply:
Loans to Businesses:
- Normal operations are severely diminished or have ceased
- Seriously impaired cash flow
- Numerous exceptions to loan agreement
- Outside accountant questions entity's survivability as a "going
concern"
- Financial statements may be received late if at all
- Material judgments filed
Loans to Businesses or Individuals:
- Original repayment terms materially altered
- Secondary source of repayment is inadequate
- Asset liquidation may be in process with all efforts directed at
debt retirement
- Documentation deficiencies not correctable
- Loss loans would have been reserved at 100% of the loan balance. Our
loan policy states that loss loans shall be reserved at 100%. Loss
loans are loans of such limited value that they do not merit
continuance as an acceptable asset, and therefore must be charged off
in full in the quarter this grade is assigned. As of December 31, 2002
and December 31, 2001, Frontier Bank did not have any loss loans.
- Loans secured by segregated deposits held by Frontier Bank are not
required to maintain an allowance reserve.
- All remaining loans, which are not secured by deposits and are not
graded as special mention, substandard, doubtful, or loss, were
reserved at 0.8% of the loan balance. This rate was developed by the
Company for the Banks using the factors first discussed above on page
30.
As of December 31, 2002, Dalton Whitfield Bank's allowance for loan losses
was $1.9 million ($1.7 million at year end 2001), or 1.45% (1.40% for 2001) of
the year-end loans outstanding at Dalton Whitfield Bank. Dalton Whitfield Bank's
peer group, as defined by the Federal Financial Institutions Examination
Council's December 31, 2002 Uniform Bank Performance Report, includes all
insured commercial banks between $100 million and $300 million average assets
with 3 or more banking offices located in a non-metropolitan area. This peer
group, which includes 912 banks, had a ratio of the allowance for loan losses
divided by total loans of 1.34% as of December 31, 2002, or 11 basis points less
than Dalton Whitfield Bank. Our policy methodology for determining this adequacy
level at December 31, 2002, is similar to Frontier Bank's and is as follows:
- Special mention loans were reserved at 5% of the loan balance. As of
December 31, 2002, Dalton Whitfield Bank had $4.4 million of special
mention loans compared to $186 thousand as of December 31, 2001.
32
- Substandard loans were reserved at 15% of the loan balance. As of
December 31, 2002, Dalton Whitfield Bank had $4.5 million of
substandard loans compared to $2.6 million as of December 31, 2001.
- Doubtful loans were reserved at 50% of the loan balance. As of
December 31, 2002, Dalton Whitfield Bank had $55 thousand of doubtful
loans compared to no doubtful loans as of December 31, 2001.
- Loss loans would have been reserved at 100% of the loan balance. As of
December 31, 2002 and December 31, 2001, Dalton Whitfield Bank did not
have any loss loans.
- Loans secured by segregated deposits held by Dalton Whitfield Bank are
not required to maintain an allowance reserve.
- All remaining loans, which are not secured by deposits and are not
graded as special mention, substandard, doubtful, or loss, were
reserved at 0.8% of the loan balance. This rate was developed by the
Company for the Banks. In 2001, these loans were reserved at 1% except
for commercial loans, which were reserved at 1.25%. At that time,
management felt higher rates were warranted due to the Dalton, Georgia
economy being closely tied to the carpet industry, and having no
historical net charge-offs data. Dalton Whitfield Bank's net
charge-offs as percentage of Dalton Whitfield Bank's average loans
were 0.46% in 2002, 0.14% in 2001, and 0.02% in 2000. Based on these
historical net charge-off rates, we believe that 0.8% is an adequate
reserve rate at December 31, 2002.
As of December 31, 2002, First State Bank's allowance for loan losses was
$362 thousand, or 1.35% of the year-end loans outstanding at First State Bank.
First State Bank's peer group, as defined by the Federal Financial Institutions
Examination Council's December 31, 2002 Uniform Bank Performance Report,
includes all insured commercial banks between $50 million and $100 million
average assets with 2 or less banking offices located in a metropolitan area.
This peer group, which includes 522 banks, had a ratio of the allowance for loan
losses divided by total loans of 1.31% as of December 31, 2002, or four basis
points less than First State Bank. Our policy methodology for determining this
adequacy level at December 31, 2002, is similar to Frontier Bank's and is as
follows:
- Special mention loans were reserved at 5% of the loan balance. As of
December 31, 2002, First State Bank had $141 thousand of special
mention loans.
- Substandard loans were reserved at 15% of the loan balances. As of
December 31, 2002, First State Bank had $516 thousand of substandard
loans.
- Doubtful loans were reserved at 50% of the loan balance. As of
December 31, 2002, First State Bank had $1 thousand of doubtful loans.
- Loss loans would have been reserved at 100% of the loan balance. As of
December 31, 2002, First State Bank did not have any loss loans.
- Loans secured by segregated deposits held by First State Bank are not
required to maintain an allowance reserve.
- All remaining loans, which are not secured by deposits and are not
graded as special mention, substandard, doubtful, or loss, were
reserved at 0.8% of the loan balance. This rate was developed by the
Company for the Banks.
While it is our policy to charge off in the current period loans for which
a loss is considered probable, there are additional risks of future losses which
cannot be quantified precisely or attributed to particular loans
33
or classes of loans. Because these risks include the state of the economy,
management's judgment as to the adequacy of the allowance is necessarily
approximate and imprecise. For further information on First Security's allowance
for loan losses, see "Management's Discussion and Analysis of Financial
Condition and Results of Operation -- Asset Quality."
NONINTEREST INCOME
Total noninterest income for 2002 was $3.8 million, compared to $2.7
million in 2001 and $1.1 million in 2000. The following table presents the
components of noninterest income for 2002, 2001, and 2000. We believe that
noninterest income will continue to improve in 2003.
NONINTEREST INCOME
For the Years ended December 31,
------------------------------------------
Percent Percent
2002 Change 2001 Change 2000
------ -------- ------ -------- ------
(Dollar amounts in thousands)
NSF Fees $1,301 33.6% $ 974 93.3% $ 504
Service charges on deposit accounts 557 36.9% 407 71.0% 238
Mortgage loan and related fees 1,316 33.9% 983 719.2% 120
Net gain on sales of available for sale securities 86 0.0% - 0.0% -
Other income 559 48.3% 377 66.8% 226
------ -------- ------ -------- ------
Total noninterest income $3,819 39.3% $2,741 151.9% $1,088
====== ======== ====== ======== ======
One of the largest sources of noninterest income for First Security is
service charges and fees on deposit accounts held by our Banks. Total service
charges, including non-sufficient funds fees, were $1.9 million, or 49% of total
noninterest income for 2002, compared with $1.4 million or 50% for 2001 and $742
thousand, or 68% for 2000. The year over year growth of deposit service charge
and fee revenue was directly related to the increase in the number of deposit
accounts from year to year. At year-end 2000, we had 9,624 transaction and
savings accounts; at year-end 2001, the number of accounts was 14,122; and at
year-end 2002, there were 21,317 accounts. We anticipate that the number of
these type accounts to continue to increase in 2003.
Mortgage loan and related fees for 2002 were $1.3 million, compared to the
2001 level of $983 thousand and the 2000 level of $120 thousand. Low interest
rates and the expansion of our mortgage operations led to the increase in our
mortgage related income. Assuming 15- and 30-year mortgage interest rates remain
stable, we anticipate that our mortgage loan fee income may remain near or above
the current level. We believe that refinancing activity will slow from the pace
of 2001 and 2002, however we are in the process of expanding our mortgage
origination operation geographically to include Knox and surrounding counties in
Tennessee. We believe that additional volume will compensate for possible
reduced nationwide refinancing activities. Substantially all of the mortgage
loan and related fees recorded during 2002 were received as the result of
originating approximately $82.7 million of residential mortgages that were
subsequently sold into the secondary market; in 2001, we originated and sold
approximately $74.1 million of residential mortgages; and, in 2000 we originated
$8.7 million. These loans were all sold with the right to service the loans (the
servicing asset) released to the purchaser for a fee.
NONINTEREST EXPENSE
Total noninterest expense for 2002 was $14.9 million, compared to $11.0
million in 2001, and $7.5 million in 2000. Noninterest expense for 2002 included
$231 thousand of charges related to the acquisition of First State Bank of
Maynardville, Tennessee, primarily for employee salaries and professional fees.
In 2000, noninterest expense included $750 thousand of similar charges related
to the acquisition of First Central Bank of Sweetwater, Tennessee. Unless
indicated otherwise in the discussion below, we anticipate increases in
noninterest expense for 2003 as a result of our acquisition of Premier National
Bank of Dalton and our
34
branching activities. The following table represents the components of
noninterest expense for the years ended December 31, 2002, 2001, and 2000.
NONINTEREST EXPENSE
For the Years ended December 31,
--------------------------------------------
Percent Percent
2002 Change 2001 Change 2000
------- -------- ------- -------- ------
(Dollar amounts in thousands)
Salaries & Benefits $ 8,299 38.48% $ 5,993 51.30% $3,961
Occupancy Expense 1,080 15.02% 939 74.86% 537
Furniture and Equipment 1,097 37.99% 795 62.91% 488
Professional Fees 946 126.32% 418 -14.87% 491
Data Processing 759 29.30% 587 84.59% 318
Printing & Supplies 377 27.36% 296 69.14% 175
Telephone 325 47.73% 220 50.68% 146
Advertising 308 9.22% 282 80.77% 156
Amortization Expense - Goodwill 102 -78.79% 481 8.58% 443
Other Expense 1,622 63.34% 993 25.86% 789
------- -------- ------- -------- ------
Total Noninterest Expense $14,915 35.54% $11,004 46.64% $7,504
======= ======== ======= ======== ======
Total salaries and benefits for 2002 increased by 38% over the 2001 level.
Most of the increase in salaries and benefits is related to our acquisition of
First State Bank, staff additions for our branch openings, and staff additions
to accommodate our growth. As of December 31, 2002, we had 16 full service
banking offices and three loan production offices with 187 full time equivalent
employees; as of December 31, 2001, we had 12 full service banking offices and
one loan production office with 139 full time equivalent employees; and, as of
December 31, 2000, we had seven full service banking offices and one loan
production office with 101 full time equivalent employees. In 2003 we plan to
convert the three loan production offices into full service branches, as well as
build three new branches in markets not currently served by us.
Total occupancy expense for 2002 increased by 15% compared with 2001, which
was 75% more than 2000. The 2002 increase is due to the acquisition of First
State Bank, as well as opening two branches and two loan production offices.
Increases in 2001 were the result of opening five branch facilities. First
Security leases nine facilities and it leases the land for one branch - see
"Properties." As a result, current period occupancy expense is higher than if we
owned these facilities, including the real estate, but conversely and due to
favorable market conditions and lease terms, we have been able to deploy the
capital into earning assets rather than capital expenditures for facilities.
Similar to occupancy expense, furniture and equipment expense increased in
2002 due to the acquisition of First State Bank and our branching efforts. From
2000 to 2001, furniture and equipment expense increased due to branch openings.
Professional fees increased $528 thousand or 126% from 2001 to 2002. The
increase was due to fees related to outsourcing internal audit and loan review
to Professional Bank Services, as well as external audit and tax services and
legal and accounting advice related to, among other things, potential
acquisitions, investment securities, trademarks, and intangible properties. In
addition, we outsourced a major portion of our information technology and
network support functions, and we had acquisition/conversion fees related to the
First State Bank acquisition. The decrease in 2001 of approximately 15% from the
2000 level was due to nonrecurring professional fees related to the acquisition
of First Central Bank of Monroe County in the year 2000.
35
Data processing expense increased $172 thousand, or 29%, from 2001 to 2002
as a result of our growth in loans and deposits, as well as our acquisition of
First State Bank. Our external data processor is Intercept (formerly Advanced
Computer Enterprises) located in Maryville, Tennessee. The monthly fees
associated with data processing are based primarily on transaction volume.
Therefore, as First Security grows, we believe that data processing costs will
increase correspondingly. The increase in the 2001 data processing expense over
2000 is due to our growth in loans and deposits in 2001 and Frontier Bank
opening in mid-2000, thus incurring half a year of data processing expense.
Printing and supplies, telephone, and advertising increased in 2002 due to
our branching efforts, as well as the acquisition of First State Bank. The
increase in 2001 from 2000 was due to branching and subsequent growth.
In 2002, intangible asset amortization expense resulted from the
amortization of the core deposit intangible asset created by the acquisition of
First State Bank. The core deposit intangible and goodwill created by this
acquisition were $1 million and $1.4 million, respectively. The estimated useful
life of the core deposit intangible is 10 years. As a result of the adoption of
SFAS 142, goodwill amortization expense has not been incurred since 2001;
however, the goodwill will be written down should the carrying value become
impaired. In 2002, we determined that the carrying value of our goodwill was not
impaired and thus no goodwill write-downs were incurred. From 2000 to 2001,
goodwill amortization expense increased due to the goodwill created by the
acquisition of First Central Bank of Monroe County, Sweetwater, Tennessee. The
goodwill associated with this acquisition was $973 thousand and began amortizing
in July 2000 (i.e. there was half of a year of amortization in 2000 and a full
year in 2001).
INCOME TAXES
First Security booked income tax expense of $1.6 million in 2002, compared
with $235 thousand in 2001, and a benefit of $347 thousand in 2000. First
Security's effective tax rates for 2002, 2001, and 2000 were 37%, 43%, and 38%,
respectively. In addition, in 2001 we incurred approximately $125 thousand of
additional tax expense as a result of a prior period under accrual. As of
December 31, 2002 and 2001, First Security's net deferred tax asset was $456
thousand and $867 thousand, respectively.
STATEMENT OF FINANCIAL CONDITION
First Security ended 2002 with consolidated assets of $472.9 million, a 31%
increase over the year-end 2001 level of $361.9 million. Consolidated assets at
year-end 2001 were 81% more than the year-end 2000 level of $199.6 million.
Asset growth is directly related to deposit growth and the funds available to
First Security for investment. In 2002, our consolidated assets increased due to
(i) the deposit gathering activities of our Banks (ii) the acquisition of First
State Bank - which had an estimated fair value of approximately $55 million in
consolidated assets on the acquisition date, July 20, 2002, and (iii) the
non-underwritten private placement of First Security's common stock through
which we raised approximately $25.7 million. Growth in 2001 was largely the
result of our branching efforts. In 2001 we opened five branches and one loan
production office; while in 2002 we opened two branches and two loan production
offices. We expect our assets to continue growing because we plan to (i) convert
our three loan production offices into full service branches, (ii) build three
branches in markets not previously served by us, and (iii) relocate two branches
to larger facilities.
First Security continues to actively pursue acquisitions and will continue
to seek means to enhance our core deposit market share through further branching
to the extent our capital will enable us to grow.
LOANS
Our loan demand has been fairly strong. Total loans increased 20% from
year-end 2001 to year-end 2002, and 90% from year-end 2000 to year-end 2001. The
increase in loans in 2002 is attributable to (i) our acquisition of First State
Bank, (ii) our experienced senior management lending team, (iii) our branching
efforts, and (iv) the low interest rate environment (in 2001, the prime-lending
rate decreased from 9.5% to
36
4.75% and decreased further to 4.25% in 2002). With the exception of the First
State Bank acquisition, total loan increases in 2001 were due to the same
factors. We believe that general loan growth will remain strong. Funding of
future loan growth may be restricted by our ability to raise core deposits,
although we will use alternative funding sources if necessary and cost
effective. Loan growth may be further restricted by the necessity for us to
maintain appropriate capital levels, as well as adequate liquidity. The
following table presents a summary of the loan portfolio by category for the
last four years.
LOANS OUTSTANDING
As of December 31,
----------------------------------------------------------------------
2002 % Change 2001 % Change 2000 % Change 1999
-------- --------- -------- --------- -------- --------- -------
(Dollars amounts in thousands)
Commercial $108,761 11.4% $ 97,625 69.8% $ 57,501 140.4% $23,914
Real estate - construction 28,701 51.7% 18,923 205.2% 6,201 195.0% 2,102
Real estate - mortgage 145,203 26.5% 114,756 99.2% 57,595 76.3% 32,673
Installment loans to individuals 64,771 8.7% 59,593 90.6% 31,268 197.2% 10,522
Other 1,146 684.9% 146 -58.0% 348 -32.2% 513
-------- --------- -------- --------- -------- --------- -------
Total loans $348,582 19.8% $291,043 90.3% $152,913 119.3% $69,724
======== ========= ======== ========= ======== ========= =======
Substantially all of First Security's loans are to customers located in
Georgia and Tennessee, in the immediate markets of our Banks. Other than a
carpet industry concentration in Dalton, Georgia (as of December 31, 2002, loans
related to the carpet industry were approximately $17 million), we believe that
First Security is not dependent on any single customer or group of customers
whose insolvency would have a material adverse effect on operations. We also
believe that the loan portfolio is diversified among loan collateral types, as
noted by the following table.
LOANS BY COLLATERAL TYPE
As of December 31,
---------------------------------------------------------------------
% of % of % of % of
2002 Loans 2001 Loans 2000 Loans 1999 Loans
-------- ------ -------- ------ -------- ------ ------- ------
(Dollar amounts in thousands)
Secured by real estate:
Construction and land development $ 28,701 8.2% $ 18,923 6.5% $ 6,201 4.1% $ 2,102 3.0%
Farmland 2,123 0.6% 1,861 0.6% 1,044 0.7% 66 0.1%
Home equity lines of credit 31,813 9.1% 23,318 8.0% 11,548 7.6% 2,891 4.1%
Residential first liens 53,528 15.4% 34,757 11.9% 13,477 8.8% 5,289 7.6%
Residential Jr. liens 2,582 0.7% 2,425 0.8% 3,798 2.5% 4,763 6.8%
Multi-family residential 7,550 2.2% 6,368 2.2% 2,101 1.4% 306 0.4%
Non-farm and non-residential 47,607 13.7% 46,027 15.8% 25,627 16.8% 19,358 27.8%
-------- ------ -------- ------ -------- ------ ------- ------
Total real-estate 173,904 49.9% 133,679 45.9% 63,796 41.7% 34,775 49.9%
Other Loans:
Commercial and industrial 108,228 31.0% 97,238 33.4% 56,919 37.2% 23,716 34.0%
Agricultural production 533 0.2% 387 0.1% 582 0.4% 198 0.3%
Credit cards and other revolving credit 717 0.2% 364 0.1% 129 0.1% - 0.0%
Consumer installment loans 64,054 18.4% 59,229 20.4% 31,139 20.4% 10,522 15.1%
Other 1,146 0.3% 146 0.1% 348 0.2% 513 0.7%
-------- ------ -------- ------ -------- ------ ------- ------
Total other loans 174,678 50.1% 157,364 54.1% 89,117 58.3% 34,949 50.1%
-------- ------ -------- ------ -------- ------ ------- ------
Total loans $348,582 100.0% $291,043 100.0% $152,913 100.0% $69,724 100.0%
======== ====== ======== ====== ======== ====== ======= ======
37
The following table sets forth the maturity distribution of the loan
portfolio as of December 31, 2002. First Security's loan policy does not permit
automatic roll-over of matured loans.
LOANS BY MATURITY
As of December 31, 2002
-------------------------------------------------------------------------------
Over three One year Three years
Less than months to to to Over five
three months twelve months three years five years years Total
------------- -------------- ------------ ------------ ---------- --------
(Dollar amounts in thousands)
Closed end 1-4 family residential $ 10,544 $ 8,009 $ 17,089 $ 16,707 $ 1,100 $ 53,449
All other loans 115,189 53,780 63,508 50,192 12,464 295,133
------------- -------------- ------------ ------------ ---------- --------
Total $ 125,733 $ 61,789 $ 80,597 $ 66,899 $ 13,564 $348,582
============= ============== ============ ============ ========== ========
ASSET QUALITY
We consider our subsidiaries' asset quality to be of primary importance. At
year-end 2002, our loan portfolio was 74% of total assets. Subsequent to
year-end, we hired a Senior Credit Administration officer and a Senior Loan
Review officer to oversee these respective practices in our Banks. We took this
action because the economy is not showing signs of recovery and because of
increases in our past due, classified, and nonaccrual loans. We do not believe
that past due, classified, and nonaccrual loans are too high, but rather that
they are trending in the wrong direction. For these reasons, we are committing
new resources toward managing the asset quality of our loan portfolio.
The allowance for loan losses represents management's estimate of an amount
adequate in relation to the risk of losses inherent in the loan portfolio. The
loan portfolio is analyzed monthly to identify potential problems. This analysis
is undertaken in conjunction with the establishment of First Security's
allowance for loan losses to provide a basis for determining the adequacy of its
loan loss reserves to absorb losses that we estimate might be experienced.
Furthermore, Credit Administration and Loan Review conduct regularly scheduled
problem-asset meetings in which past due and classified loans are thoroughly
analyzed. In addition to these analyses of existing loans, management considers
the Banks' historical loan losses, past due and non-performing loans, current
economic conditions, underlying collateral values securing loans, and other
factors which may affect probable loan losses. Furthermore, as the Banks' loan
staff continues to increase the loan portfolio through new loan accounts, such
new loans have limited historical loss experience on which to base a specific
reserve. First Security's methodology for determining the adequacy of the
allowance for loan losses is explained in further detail in "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Provision for Loan Losses."
The following table presents a summary of changes in the allowance for loan
losses for the past three years. In 2002, loan charge-offs increased over the
level in 2001. Our 2002 and 2001 net charge-offs as a percentage of average
loans were 0.25% and 0.28%, respectively, or two basis points more than our
Banks' blended peer group average of 0.23% and 0.26%, respectively. Net
charge-offs as a percentage of average loans was low (0.02%) in 2000 because our
loan portfolio was relatively new and as part of our 1999 acquisition of the
Colonial branches, First Security had a loan purchase option so that Dalton
Whitfield Bank did not purchase the loans that it deemed to be potentially bad
credits at that time.
38
ANALYSIS OF CHANGES IN ALLOWANCE FOR LOAN LOSSES
Colonial Bank
First Security Branches
---------------------------------------------- -----------
Four Months Eight Months
Ended Ended
For the years ended December 31, December 31, August 31,
2002 2001 2000 1999 1999
---------- ---------- ---------- ---------- -----------
(Dollar amounts in thousands)
Allowance for loan losses -
Beginning of period $ 3,825 $ 1,942 $ 1,057 $ - $ 1,177
Provision for loan losses 1,948 2,496 811 - 280
Additions due to business combinations 377 - 94 1,088 -
---------- ---------- ---------- ---------- -----------
Total 6,150 4,438 1,962 1,088 1,457
Amounts charged off:
Commercial 414 381 - - 11
Real estate - construction - 51 - - -
Real estate - residential mortgage 22 - - - 171
Consumer 432 190 24 31 52
---------- ---------- ---------- ---------- -----------
Total loans charged off 868 622 24 31 234
---------- ---------- ---------- ---------- -----------
Recoveries of charged-off loans
Commercial 54 4 - - 219
Real estate - construction - - - - -
Real estate - residential mortgage - - - - 2
Consumer 26 5 4 - 2
---------- ---------- ---------- ---------- -----------
Total recoveries 80 9 4 - 223
---------- ---------- ---------- ---------- -----------
Net Charge-offs 788 613 20 31 11
---------- ---------- ---------- ---------- -----------
Allowance for loan losses - end of period $ 5,362 $ 3,825 $ 1,942 $ 1,057 $ 1,446
========== ========== ========== ========== ===========
Total loans - end of period $ 348,582 $ 291,043 $ 152,913 $ 69,724 $ 61,502
Average loans $ 311,774 $ 221,624 $ 107,483 $ 48,439 $ 67,064
As a percentage of average loans:
Net charge-offs 0.25% 0.28% 0.02% 0.06% 0.02%
Provision for loan losses 0.62% 1.13% 0.75% 0.00% 2.16%
Allowance for loan losses as a percentage of:
Year end loans 1.54% 1.31% 1.27% 1.52% 2.35%
Non-performing assets 709.26% 634.22% 1765.45% 414.51% 1475.51%
We believe that the allowance for loan losses at December 31, 2002 is
sufficient to absorb losses inherent in the loan portfolio based on our
assessment of the information available. Our assessment involves uncertainty and
judgment; therefore, the adequacy of the allowance for loan losses cannot be
determined with precision and may be subject to change in future periods. In
addition, bank regulatory authorities, as part of their periodic examinations of
our Banks, may require additional charges to the provision for loan losses in
future periods if the results of their reviews warrant. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Provision for Loan Losses."
As explained in the section titled "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Provision for Loan Losses,"
Frontier Bank has a chartering condition that requires it to maintain a minimum
allowance for loan losses of 1.25% of total loans. As a result, we believe that
in years past our allowance contained reserves in excess of what was determined
to be adequate at year-end. The allocation of the allowance for loan losses by
loan category at the dates indicated is presented below.
39
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
December 31,
2002 2001 2000
------------------------------ ---------------------------- ---------------------
Percent of Percent of Percent of
loans in each loans in each loans in each
category to category to category to
Amount total loans Amount total loans Amount total loans
-------------- -------------- -------------- ------------ ------- ------------
(Dollar amounts in thousands)
Commercial $ 2,446 31.2% $ 1,415 33.5% $ 719 37.6%
Real estate - construction 271 8.2% 162 6.5% 93 4.1%
Real estate - mortgage 1,650 41.7% 1,036 39.4% 648 37.7%
Consumer 672 18.9% 568 20.6% 391 20.4%
Charter condition and unallocated 323 0.0% 644 0.0% 91 0.2%
-------------- -------------- -------------- ------------ ------- ------------
Total $ 5,362 100.0% $ 3,825 100.0% $ 1,942 100.0%
============== ============== ============== ============ ======= ============
December 31,
1999
----------------------------
Percent of
loans in each
category to
Amount total loans
-------------- ------------
(Dollar amounts in thousands)
Commercial $ 359 34.3%
Real estate - construction 32 3.0%
Real estate - mortgage 327 46.9%
Consumer 210 15.1%
Charter condition and unallocated 129 0.7%
-------------- ------------
Total $ 1,057 100.0%
============== ============
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, accruing loans contractually
past due 90 days or more, restructured loans, other real estate, and other real
estate under contract for sale. Loans are placed on non-accrual status when
management has concerns relating to the ability to collect the loan principal
and interest, and generally when such loans are 90 days or more past due.
Nonaccrual loans totaled $667 thousand, $519 thousand and $63 thousand as of
December 31, 2002, 2001, and 2000, respectively. Interest of $27 thousand, $24
thousand and $3 thousand was reported on these loans during 2002, 2001, and
2000, respectively. If these loans had been performing, we would have earned an
additional $12 thousand, $13 thousand, and less than $1 thousand in 2002, 2001,
and 2000, respectively. No amount of loans that have been classified by
regulatory examiners as loss, substandard, doubtful, or special mention has been
excluded from amounts disclosed as nonperforming loans. Nonperforming assets
represent potential losses to First Security; however, in compliance with FAS
114, we have measured the impairment of these loans and adjusted them to either
the present value of expected future cash flows, the fair value of the
collateral, or the observable market price.
There are no commitments to lend additional funds to customers with loans
on non-accrual status at December 31, 2002. The table below summarizes First
Security's non-performing assets for the last three years.
NONPERFORMING ASSETS
As of December 31,
2002 2001 2000 1999
------ ------ ------ ------
(Dollar amounts in thousands)
Nonaccrual loans $ 667 $ 519 $ 63 $ -
Loans past due 90 days and still accruing 89 21 47 255
------ ------ ------ ------
Total nonperforming loans 756 540 110 255
Other real estate owned - - - -
------ ------ ------ ------
Total nonperforming assets $ 756 $ 540 $ 110 $ 255
====== ====== ====== ======
Nonperforming loans as a percentage of total loans 0.22% 0.19% 0.07% 0.37%
Nonperforming assets as a percentage of total assets 0.16% 0.15% 0.06% 0.23%
INVESTMENT SECURITIES AND OTHER EARNING ASSETS
The composition of our securities portfolio reflects our investment
strategy of maintaining an appropriate level of liquidity while providing a
relatively stable source of income. Our securities portfolio also
40
provides a balance to interest rate risk and credit risk in other categories of
the balance sheet while providing a vehicle for investing available funds,
furnishing liquidity, and supplying securities to pledge as required collateral
for certain deposits and borrowed funds. We use two categories to classify our
securities: "held to maturity" or "available for sale." While First Security has
no plans to liquidate a significant amount of any securities, the securities
available for sale may be used for liquidity purposes should management deem it
to be in our best interest.
Securities totaled $54.4 million at December 31, 2002, compared to $37.3
million at December 31, 2001. The growth in the securities portfolio occurred as
a result of our efforts to improve our liquidity, as well as the acquisition of
First State Bank. At December 31, 2002, the securities portfolio had unrealized
net gains of approximately $903 thousand. In addition, all investment securities
purchased to date have been classified as available-for-sale. Our securities
portfolio at December 31, 2002 consisted of United States government agency
bonds, federal agency bonds, mortgage backed securities, asset backed securities
(SLMA), tax-exempt municipal securities, and taxable municipal securities. The
following table provides the carrying values of our securities by their stated
maturities (this maturity schedule excludes security prepayment and call
features), as well as the tax equivalent yields for each maturity range.
MATURITY OF INVESTMENT SECURITIES - CARRYING VALUES
Less than One year to Five years to More than
Investment Security Type one year five years ten years ten years
- ---------------------------------------------------------------------------------------
(Dollar amounts in housands)
Municipal - tax exempt $ 1,019 $ 3,838 $ 3,335 $ 2,900
Municipal - taxable 448 1,189 - -
Agency bonds 3,135 10,282 5,613 -
Agency issued remics 444 7,872 - -
Agency issued pools - 11,715 1,083 458
Asset backed - 208 - -
- --------------------------------------------------------------------------------------
Total $ 5,046 $ 35,104 $ 10,031 $ 3,358
========================================================
========================================================
Tax equivalent yield 3.60% 4.34% 4.67% 5.51%
========================================================
We currently have the ability and intent to hold our available-for-sale
investment securities to maturity. However, should conditions change, we may
sell unpledged securities. Our management considers the overall quality of the
securities portfolio to be high. All securities held are traded in liquid
markets, except for one bond. This $250 thousand investment is a Qualified Zone
Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code
of 1986, as amended) issued by The Health, Educational and Housing Facility
Board of the County of Knox under the authority from the State of Tennessee. As
of December 31, 2002, we owned securities from issuers in which the aggregate
book value from such issuers exceeded 10% of our stockholders equity. As of
year-end 2002, the book value and market value of the securities from each such
issuer are as follows:
(Dollar amounts in thousands) Book Value Market Value
Fannie Mae $ 15,834 $ 16,235
Federal Home Loan Mortgage Corporation $ 15,409 $ 15,734
Federal Home Loan Bank (FHLB) $ 7,214 $ 7,386
See the notes to the financial statements for the book values of the
investments for the dates presented in the consolidated balance sheets.
Federal funds sold increased to $30 million at December 31, 2002 from $0 at
December 31, 2001. The increase resulted from our efforts to increase our
liquidity (see "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity"), as well as our efforts to sell our
41
common stock through our recent private placement offering. We plan to invest a
portion of these federal funds into liquid investment securities and loans to
improve our yield on these earning assets.
As of December 31, 2002, First Security held $1.3 million in certificates
of deposit at other FDIC insured financial institutions. First State Bank
purchased these earning assets prior to First Security acquiring First State
Bank. We do not intend to renew the certificates upon maturity, but rather we
will invest the funds in liquid investment securities or loans.
DEPOSITS AND OTHER BORROWINGS
Deposits increased by 31% from year-end 2001 to year-end 2002 due to (i)
our acquisition of First State Bank, (ii) our management team drawing customers
away from other financial institutions, and (iii) our branching efforts which
are discussed in "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Statement of Financial Condition." We believe that
by improving our branching network, we will provide more convenient
opportunities for customers to bank with us, and thus improve our core deposit
funding. For this reason, in 2003 we plan to convert three loan production
offices into full service branches, build three new branches in new markets, and
relocate two branches into larger facilities. As a result of these future
branches and the pending acquisition of Premier National Bank of Dalton, we
anticipate that our deposits will continue to increase in 2003. The table below
is a maturity schedule for our certificates of deposit in amounts of $100
thousand or more.
Less than Three months Six months Greater than
(Dollar amounts in thousands) 3 months to six months to twelve months twelve months
-------------------------------------------------------------
Certificates of deposit of $100 thousand or more $ 22,570 $ 17,468 $ 21,636 $ 13,486
In January of 2002, First Security borrowed $6 million in term notes (see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity") from the Federal Home Loan Bank of Cincinnati. The
following table details the maturities and rates of the term debt.
Date Type Principal Term Rate Maturity
- --------------------------------------------------------------------------
1/8/2002 Fixed Rate Advance $ 500,000 24 mos 3.73% 1/8/04
1/8/2002 Fixed Rate Advance 500,000 36 mos 4.48% 1/7/05
1/8/2002 Fixed Rate Advance 500,000 48 mos 5.04% 1/6/06
1/10/2002 Fixed Rate Advance 500,000 24 mos 3.65% 1/9/04
1/10/2002 Fixed Rate Advance 500,000 36 mos 4.45% 1/10/05
1/10/2002 Fixed Rate Advance 500,000 48 mos 5.00% 1/10/06
1/15/2002 Fixed Rate Advance 500,000 24 mos 3.50% 1/15/04
1/15/2002 Fixed Rate Advance 500,000 36 mos 4.22% 1/14/05
1/15/2002 Fixed Rate Advance 500,000 48 mos 4.77% 1/13/06
1/17/2002 Fixed Rate Advance 500,000 24 mos 3.66% 1/16/04
1/17/2002 Fixed Rate Advance 500,000 36 mos 4.37% 1/14/05
1/17/2002 Fixed Rate Advance 500,000 48 mos 4.90% 1/17/06
----------
$6,000,000
==========
Aggregate composite rate 4.31%
24 mo composite rate 3.64%
36 mo composite rate 4.38%
48 mo composite rate 4.93%
42
INTEREST RATE SENSITIVITY
Financial institutions are subject to interest rate risk to the degree that
their interest-bearing liabilities (consisting principally of customer deposits)
mature or reprice more or less frequently, or on a different basis, than their
interest-earning assets (generally consisting of intermediate or long-term loans
and investment securities). The match between the scheduled repricing and
maturities of First Security's earning assets and liabilities within defined
time periods is referred to as "gap" analysis. At December 31, 2002, the
cumulative one-year gap for First Security (as consolidated) was a positive (or
asset sensitive) $39.6 million, or 9% of total earning assets. This means assets
reprice slightly faster than liabilities under rate changes.
Intense competition in First Security's markets continues to pressure
quality loan rates downward, while conversely pressuring deposit rates upward.
The following table reflects First Security's rate sensitive assets and
liabilities by maturity as of December 31, 2002. Variable rate loans are shown
in the category of due "one to three months" because they reprice with changes
in the prime lending rate. Fixed rate loans are presented assuming the entire
loan matures on the final due date. Actually, payments are made at regular
intervals and are not reflected in this schedule. Additionally, demand deposits
and savings accounts have no stated maturity; however, it has been First
Security's experience that these accounts are not totally rate sensitive, and
accordingly the following analysis assumes 11% of interest bearing demand
deposit accounts, 25% of money market deposit accounts, and 20% of savings
accounts reprice within one year and the remaining accounts reprice within one
to five years.
INTEREST RATE GAP SENSITIVITY
As of December 31, 2002
-------------------------------------------------------------------------------
Over Five
Years and
One through Four through One through Non-rate
Immediate Three Months Twelve Months Five Years Sensitive Total
---------- ------------- --------------- ------------ ----------- --------
(Dollar amounts in thousands)
Interest Earning Assets:
Interest bearing deposits $ 2,370 $ 190 $ 572 $ 574 $ - $ 3,706
Federal Funds Sold 30,044 - - - - 30,044
Securities - 2,636 7,368 25,938 18,500 54,442
Mortgage loans held for sale - 7,377 - - - 7,377
Loans - 118,356 61,789 147,496 13,564 341,205
-------------------------------------------------------------------------------
Total interest earning assets 32,414 128,559 69,729 174,008 32,064 436,774
Interest Bearing Liabilities:
Demand deposits - 1,522 1,522 24,635 - 27,679
MMDA deposits - 10,250 10,250 61,496 - 81,996
Savings deposits - 1,759 1,759 14,067 - 17,585
Time deposits - 53,714 98,612 40,562 - 192,888
Fed Funds Purchased/Repos 11,722 - - - - 11,722
Other borrowings - - - 6,000 168 6,168
-------------------------------------------------------------------------------
Total interest bearing liabilities 11,722 67,245 112,143 146,760 168 338,038
Non-interest bearing sources of funds - - - - 64,336 64,336
Interest sensitivity gap 20,692 61,314 (42,414) 27,248 (32,440) 34,400
-------------------------------------------------------------------------------
Cumulative sensitivity gap $ 20,692 $ 82,006 $ 39,592 $ 66,840 $ 34,400 $ -
===============================================================================
43
LIQUIDITY
Liquidity refers to First Security's ability to adjust its future cash
flows to meet the needs of our daily operations. First Security relies primarily
on management service fees from its Banks to fund our daily operations liquidity
needs. Additionally, in connection with our 2002 private placement stock
offering, we retained a portion of the proceeds of the offering as working
capital and a portion of the proceeds for future investment into our
subsidiaries. This cash, which totaled approximately $11.4 million as of
December 31, 2002, is available for funding activities for which our Banks would
not receive direct benefit, such as acquisition due diligence, shareholder
relations, and holding company reporting and operations. These funds should
adequately meet our cash flow needs. If we determine that our cash flow needs
will be satisfactorily met, we may deploy a portion of the funds into one or all
of our subsidiaries or use them in an acquisition in order to support continued
growth.
The liquidity of our Banks refers to the ability or financial flexibility
to adjust their future cash flows to meet the needs of depositors and borrowers
and to fund operations on a timely and cost effective basis. The primary sources
of funds for the Banks are cash generated by repayments of outstanding loans,
interest payments on loans, and new deposits. Additional liquidity is available
from the maturity and earnings on securities and liquid assets, as well as the
ability to liquidate securities available for sale.
At December 31, 2002, our liquidity ratio (defined as cash, due from banks,
federal funds sold, and investment securities less securities pledged to
liabilities divided by short-term funding liabilities less liabilities pledged
by securities) was 23.1% (excluding anticipated loan repayments). Three, six,
nine, and twelve months earlier on September 30th, June 30th, March 31st and
December 31st, our liquidity ratios were 25.9%, 21.8%, 16.8% and 12.7%,
respectively. Throughout the 2002, our liquidity ratio has improved
significantly due to the following deliberate actions. During the third quarter,
our liquidity increased due primarily to our acquisition of First State Bank,
which had a liquidity ratio above 50%. We do not intend to maintain First State
Bank's liquidity ratio at this high level; instead, in the fourth quarter we
began to change its mix of earning assets so that a greater percentage of them
are invested in higher yielding loans. During the second quarter, the majority
of our liquidity improvement resulted from our private placement stock offering.
During the first quarter, we improved our liquidity ratio and reduced our
dependency on overnight borrowings using two methods: (i) replacing Federal Home
Loan Bank overnight funds with FHLB term funds and (ii) selling loan
participations. Frontier Bank is a member of the Federal Home Loan Bank of
Cincinnati and, prior to year-end, attained borrowing capability secured by a
blanket lien on its 1-4 family residential mortgage loan portfolio. In January
2002, management determined, because interest rates were low, to convert the
FHLB overnight funding, as well as a portion of federal funds purchased, into $6
million of FHLB term borrowings. The terms on the borrowings are $2 million for
two years, $2 million for three years, and $2 million for four years. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Deposits and Other Borrowings." By using term borrowings we locked
in low cost funding and we improved our liquidity ratio by decreasing our
dependency on overnight liabilities. Frontier Bank also used its borrowing
capacity to purchase a letter of credit from the FHLB that we pledged to the
State of Tennessee Bank Collateral Pool. The letter of credit allows us to
release investment securities from the Collateral Pool and thus improve our
liquidity ratio. Additionally, Frontier Bank could increase its borrowing
capacity at the FHLB, subject to more stringent collateral requirements, by
pledging loans other than 1-4 family residential mortgage loans. Dalton
Whitfield Bank and First State Bank are members of the Federal Home Loan Bank of
Atlanta and the Federal Home Loan Bank of Cincinnati, respectively; however,
neither Dalton Whitfield Bank nor First State Bank currently has any FHLB
borrowings but may in the future.
Cumulatively, our Banks also had unsecured federal funds lines in the
aggregate amount of $32.5 million at December 31, 2002 under which they can
borrow funds to meet short-term liquidity needs. Subsequent to year-end, two
additional unsecured lines of credit totaling $4 million were added, bringing
the total to $36.5 million. Another source of funding is loan participations
sold (in which we retain the service rights) to other commercial banks. As of
year-end, we had $28.2 million in loan participations sold. First Security may
continue to sell loan participations as a source of liquidity. An additional
source of short-term
44
funding would be to pledge investment securities against a line of credit at a
commercial bank. As of year-end, we had no borrowings against our investment
securities, except for repurchase agreements attained in the ordinary course of
business. To date, First Security has not used brokered deposits or Internet
deposits as a source of funding, and our certificates of deposit greater than
$100 thousand were generated in our Banks' communities. Management believes that
First Security's liquidity sources are adequate to meet our Banks' operating
needs.
First Security also has contractual cash obligations and commitments, which
included certificates of deposit, other borrowings, operating leases, and loan
commitments. As of December 31, 2002, certificates of deposit totaled $192.9
million (see Note 7 - "Deposits" to the financial statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operation -
deposits and Other Borrowings"). At year-end 2002, other borrowings included $6
million in FHLB advances (see Management's Discussion and Analysis of Financial
Condition and Results of Operation - Deposits and Other Borrowings). Unfunded
loan commitments totaled $73 million at year-end (see the footnotes to the
financial statements for a break down by loan commitment type). The following
table illustrates our lease obligations, which included property and equipment
leases, as of December 31, 2002, as well as a property lease on our new
Knoxville branch, which was entered into subsequent to year-end.
(Dollars amounts in thousands) Less than 1 year 1 to 3 years 3 to 5 years After 5 years Total
Lease obligations $ 592 $ 866 $ 754 $ 739 $2,951
Net cash provided from or used by operations results primarily from net
income or loss, adjusted for the following noncash accounting items: provision
for loan losses, depreciation and amortization, and deferred income taxes or
benefits. These items amounted to cash provided of $3.9 million in 2002, $3.2
million in 2001, and $274 thousand in 2000. During 2002, 2001 and 2000, cash
provided by operations was available to increase earning assets.
CAPITAL RESOURCES
Banks and bank holding companies, as regulated institutions, must meet
required levels of capital. (See "Supervision and Regulation.") The FDIC and the
Federal Reserve, the primary federal regulators for our subsidiaries and First
Security, respectively, have adopted minimum capital regulations or guidelines
that categorize components and the level of risk associated with various types
of assets. Financial institutions are expected to maintain a level of capital
commensurate with the risk profile assigned to their assets in accordance with
the guidelines. In addition to these guidelines, Frontier Bank has a standard
chartering condition that requires it to maintain an 8% leverage ratio for its
first three years of operations (Dalton Whitfield Bank had the same condition
which lapsed in September 2002 at the conclusion of its third year of
operations). First Security and its Banks all maintain capital levels exceeding
the minimum levels required by Frontier Bank's chartering condition, in addition
to exceeding those capital requirements for well capitalized banks and bank
holding companies under applicable regulatory guidelines.
Dalton First
Well Adequately First Whitfield Frontier State
December 31, 2002 Capitalized Capitalized Security Bank Bank Bank
- -------------------------------------- ------------ ------------ --------- ---------- --------- ------
Tier I capital to risk adjusted assets 6.0% 4.0% 16.4% 11.1% 11.0% 37.0%
Total capital to risk adjusted assets 10.0% 8.0% 17.6% 12.3% 12.3% 38.2%
Leverage ratio 5.0% 4.0% 12.6% 8.3% 9.2% 19.9%
On March 19, 2002, First Security's non-underwritten private placement of
up to $20 million in shares of First Security's $.01 par value common stock at a
price of $10 per share became effective. Subsequently, the private placement
was increased from $20 million to $25 million and then again to $27.5 million.
The private placement closed on August 8, 2002, by which time First Security had
sold 2,576,460 shares in the offering to accredited investors. We relied upon
Rule 506 of regulation D of the Securities Act of 1933 to exempt this
transaction from registration under the federal securities laws. No
underwriters were involved in this transaction.
45
EFFECTS OF INFLATION
Inflation generally increases the cost of funds and operating overhead,
and, to the extent loans and other assets bear variable rates, the yields on
such assets. Unlike most industrial companies, virtually all of our assets and
liabilities are monetary in nature. As a result, interest rates generally have a
more significant impact on our performance than the effects of general levels of
inflation have. Although interest rates do not necessarily move in the same
direction, or to the same extent, as the prices of goods and services, increases
in inflation generally have resulted in increased interest rates, and the
Federal Reserve increased the interest rate three times in 1999 for a total of
75 basis points in an attempt to control inflation. However, the Federal Reserve
also reduced interest rates on eleven occasions for a total of 475 basis points
in 2001 and one time for 50 basis points in 2002 in an attempt to stimulate the
economy.
In addition, inflation results in an increased cost of goods and services
purchased, cost of salaries and benefits, occupancy expense and similar items.
Inflation and related increases in interest rates generally decrease the market
value of investments and loans held and may adversely affect the liquidity and
earnings of our commercial banking and mortgage banking business, and our
shareholders' equity. With respect to our mortgage banking business, mortgage
originations and refinancings tend to slow as interest rates increase, and
increased interest rates would likely reduce our earnings from such activities
and the income from the sale of residential mortgage loans in the secondary
market.
ACCOUNTING AND REGULATORY MATTERS
SEGMENT REPORTING
Upon incorporation, First Security adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS 131). This accounting standard revises the definition
of reportable "segments" and the presentation of related disclosures. The
standard focuses on the identification of reportable segments on the basis of
discrete business units and their financial information to the extent such units
are reviewed by an entity's "chief decision maker" (which can be an individual
or group of management persons). SFAS 131 permits aggregation or combination of
segments that have similar characteristics. In First Security's operations, the
Bank subsidiaries and their respective branches are viewed by management as
being a separately identifiable business or segment from the perspective of
monitoring performance and allocation of financial resources. Although the Banks
and their respective branches operate independently and are managed and
monitored separately, each is substantially similar in terms of business focus,
type of customers, products, and services. Further, First Security and its Banks
are subject to substantially similar laws and regulations unique to the banking
industry. Accordingly, First Security's consolidated financial statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" reflect the presentation of segment information on an aggregated
basis in one reportable segment.
SARBANES-OXLEY ACT OF 2002
On July 30, 2002, the Sarbanes-Oxley Act of 2002 was signed into law. The
Sarbanes-Oxley Act represents a comprehensive revision of laws affecting
corporate governance, accounting obligations and corporate reporting. The
Sarbanes-Oxley Act is applicable to all companies with equity or debt securities
registered under the Securities Exchange Act of 1934. In particular, the
Sarbanes-Oxley Act establishes: (i) new requirements for audit committees,
including independence, expertise, and responsibilities; (ii) additional
responsibilities regarding financial statements for the Chief Executive Officer
and Chief Financial Officer of the reporting company; (iii) new standards for
auditors and regulation of audits; (iv) increased disclosure and reporting
obligations of the reporting company and their directors and executive officers;
and (v) new and increased civil and criminal penalties for violation of the
securities laws. Many of the provisions became effective immediately while other
provisions became effective over a
46
period of 30 to 270 days and are subject to rulemaking by the Securities and
Exchange Commission. Although we anticipate that First Security will incur
additional expense to comply with the provisions of the Sarbanes-Oxley Act and
the resulting regulations, we do not expect that such compliance will have a
material impact on our results of operations or financial condition.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 - "Summary of Significant Accounting Policies" to the financial
statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk, with respect to First Security, is the risk of loss arising
from adverse changes in interest rates and prices. The risk of loss can result
in either lower fair market values or reduced net interest income. Although we
manage other risk, such as credit and liquidity, management considers interest
rate risk to be the more significant market risk and it could potentially have
the largest material effect on our financial condition. Further, we believe the
potential reduction of net interest income to be more significant than the
effect of reduced fair market values. First Security does not maintain a trading
portfolio or deal in international instruments, and therefore First Security is
not exposed to risk inherent to trading activities and foreign currency.
First Security's interest rate risk management is the responsibility of the
Asset/Liability Management Committee ("ALCO"). ALCO has established policies and
limits to monitor, measure and coordinate First Security's sources, uses, and
pricing of funds.
Interest rate risk represents the sensitivity of earnings to changes in
interest rates. As interest rates change, the interest income and expense
associated with First Security's interest sensitive assets and liabilities also
change, thereby impacting net interest income, the primary component of our
earnings. ALCO utilizes the results of both a static and dynamic gap report to
quantify the estimated exposure of net interest income to a sustained change in
interest rates.
The gap analysis projected net interest income based on both a rise and
fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month
period. The model is based on actual repricing dates of interest sensitive
assets and interest sensitive liabilities. The model incorporates assumptions
regarding the impact of changing interest rates on the prepayment rates of
certain assets.
First Security measures this exposure based on an immediate change in
interest rates of 200 basis points up or down. Given this scenario, First
Security had, at year-end, an exposure to falling rates and a benefit from
rising rates. More specifically, the model forecasts a decline in net interest
income of $2 million or 12%, as a result of a 200 basis point decline in rates.
The model also predicts a $1.7 million increase in net interest income, or 10%,
as a result of a 200 basis point increase in rates. The forecasted results of
the model are within the limits specified by ALCO. The following chart reflects
First Security's sensitivity to changes in interest rates as of December 31,
2002. Numbers are based on a static balance sheet and assumes paydowns and
maturities of both assets and liabilities are reinvested in like instruments at
current interest rates, rates down 200 basis points, and rates up 200 basis
points.
INTEREST RATE RISK
INCOME SENSITIVITY SUMMARY
(Dollar amounts in thousands) Down 200 BP Current Up 200 BP
-------------------------------------
Net interest income $ 15,174 $ 17,204 $ 18,952
change net interest income (2,030) - 1,748
% change net interest income -11.80% 0.00% 10.16%
The preceding sensitivity analysis is a modeling analysis, which changes
periodically and consists of hypothetical estimates based upon numerous
assumptions including interest rate levels, shape of the yield
47
curve, prepayments on loans and securities, rates on loans and deposits,
reinvestments of paydowns and maturities of loans, investments and deposits, and
other assumptions. In addition, there is no input for growth or a change in
asset mix. While assumptions are developed based on the current economic and
market conditions, management cannot make any assurances as to the predictive
nature of these assumptions including how customer preferences or competitor
influences might change.
As market conditions vary from those assumed in the sensitivity analysis,
actual results will differ. Also, the sensitivity analysis does not reflect
actions that ALCO might take in responding to or anticipating changes in
interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
48
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 2002 and 2001 F-3/F-4
Consolidated Statements of Operations for the Years Ended
December 31, 2002, 2001 and 2000 F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2002, 2001 and 2000 F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000 F-7/F-8
Notes to Consolidated Financial Statements F-9/F-36
F - 1
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
First Security Group, Inc.
Chattanooga, Tennessee
We have audited the accompanying consolidated balance sheets of First Security
Group, Inc. and subsidiaries (Company) as of December 31, 2002 and 2001 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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 consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated 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 First Security
Group, Inc. and subsidiaries as of December 31, 2002 and 2001 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
JOSEPH DECOSIMO AND COMPANY, LLP
Chattanooga, Tennessee
January 31, 2003
F - 2
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
(in thousands)
ASSETS
Cash and Due from Banks $ 14,429 $ 17,899
Federal Funds Sold and Securities Purchased
Under Agreements to Resell 30,044 -
-------- --------
Cash and Cash Equivalents 44,473 17,899
-------- --------
Interest-Bearing Deposits in Banks 3,706 -
-------- --------
Securities Available for Sale 54,442 37,287
-------- --------
Loans 348,582 291,043
Less: Allowance for Loan Losses 5,362 3,825
-------- --------
343,220 287,218
-------- --------
Premises and Equipment, net 12,995 9,829
-------- --------
Goodwill 7,617 6,193
-------- --------
Other Assets 6,471 3,440
-------- --------
TOTAL ASSETS $472,924 $361,866
======== ========
The accompanying notes are an integral part of the financial statements.
F - 3
2002 2001
(in thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits -
Noninterest-Bearing Demand $ 64,336 $ 48,347
Interest-Bearing Demand 27,679 22,051
-------- ---------
92,015 70,398
-------- ---------
Savings and Money Market Accounts 99,580 61,754
-------- ---------
Time Deposits -
Certificates of Deposit of $100 thousand or more 75,160 64,885
Certificates of Deposit of less than $100 thousand 117,728 96,840
-------- ---------
192,888 161,725
-------- ---------
Total Deposits 384,483 293,877
Federal Funds Purchased and Securities Sold Under
Agreements to Repurchase 11,722 21,528
Other Liabilities 2,618 2,586
Other Borrowings 6,168 4,610
-------- ---------
Total Liabilities 404,991 322,601
-------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common Stock - $.01 par value - 20,000,000 shares authorized;
7,579,104 shares issued for 2002 and 5,002,644 issued for 2001 76 50
Paid-In Surplus 65,723 40,054
Retained Earnings (Deficit) 1,539 (1,063)
Accumulated Other Comprehensive Income 595 224
-------- ---------
Total Stockholders' Equity 67,933 39,265
-------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $472,924 $361,866
======== =========
F - 4
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
INTEREST INCOME
Loans, including fees $ 23,144 $ 18,886 $ 10,219
Debt Securities 2,007 1,635 1,125
Other 470 272 480
------------- ------------- --------------
Total Interest Income 25,621 20,793 11,824
------------- ------------- --------------
INTEREST EXPENSE
Interest-Bearing Demand Deposits 249 305 231
Savings Deposits and Money Market Accounts 1,583 1,303 582
Certificates of Deposit of $100 thousand or more 2,450 2,852 1,471
Certificates of Deposit of less than $100 thousand 3,665 4,934 3,003
Other 470 389 223
------------- ------------- --------------
Total Interest Expense 8,417 9,783 5,510
------------- ------------- --------------
NET INTEREST INCOME 17,204 11,010 6,314
Provision for Loan Losses 1,948 2,496 811
------------- ------------- --------------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 15,256 8,514 5,503
------------- ------------- --------------
NONINTEREST INCOME
Service Charges on Deposit Accounts 1,858 1,381 742
Other 1,875 1,362 346
Net Gain on Sales of Available-for-Sale Securities 86 - -
------------- ------------- --------------
Total Noninterest Income 3,819 2,743 1,088
------------- ------------- --------------
NONINTEREST EXPENSES
Salaries and Employee Benefits 8,299 5,993 3,961
Net Occupancy 1,080 939 537
Other 5,536 4,072 3,006
------------- ------------- --------------
Total Noninterest Expenses 14,915 11,004 7,504
------------- ------------- --------------
INCOME (LOSS) BEFORE INCOME TAX PROVISION (BENEFIT) 4,160 253 (913)
Income Tax Provision (Benefit) 1,558 235 (347)
------------- ------------- --------------
NET INCOME (LOSS) $ 2,602 $ 18 $ (566)
============= ============= ==============
NET INCOME (LOSS) PER SHARE:
Basic $ 0.40 $ - $ (0.14)
============= ============= ==============
Diluted $ 0.39 $ - $ (0.14)
============= ============= ==============
The accompanying notes are an integral part of the financial statements.
F - 5
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
RETAINED ACCUMULATED OTHER TOTAL
COMMON STOCK PAID-IN EARNINGS COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT SURPLUS (DEFICIT) INCOME (LOSS) EQUITY
BALANCE - December 31,1999 4,106 $ 41 $ 31,546 $ (515) $ (56) $ 31,016
Net Loss (566) (566)
Change in Net Unrealized Loss on
Securities Available for Sale, net of tax 144 144
------ ------- -------- ---------- --------------- ---------------
BALANCE - December 31, 2000 4,106 41 31,546 (1,081) 88 30,594
Issuance of Common Stock 897 9 8,508 8,517
Net Income 18 18
Change in Net Unrealized Gain on
Securities Available for Sale, net of tax 136 136
------ ------- -------- ---------- --------------- ---------------
BALANCE - December 31, 2001 5,003 50 40,054 (1,063) 224 39,265
Issuance of Common Stock 2,576 26 25,669 25,695
Net Income 2,602 2,602
Change in Net Unrealized Gain on
Securities Available for Sale, net of tax 371 371
------ ------- -------- ---------- --------------- ---------------
BALANCE - DECEMBER 31, 2002 7,579 $ 76 $ 65,723 $ 1,539 $ 595 $ 67,933
====== ======= ======== ========== =============== ===============
TOTAL
COMPREHENSIVE
INCOME (LOSS)
---------------
Year Ended December 31,2000
Comprehensive Loss -
Net Loss $ (566)
Change in Net Unrealized Loss on
Securities Available for Sale, net of tax 144
---------------
Total Comprehensive Loss $ (422)
===============
Year Ended December 31, 2001
Comprehensive Income -
Net Income $ 18
Change in Net Unrealized Gain on
Securities Available for Sale, net of tax 136
---------------
Total Comprehensive Income $ 154
===============
Year Ended December 31, 2002
Comprehensive Income
Net Income $ 2,602
Change in Net Unrealized Gain on
Securities Available for Sale, net of tax 371
---------------
Total Comprehensive Income $ 2,973
===============
The accompanying notes are an integral part of the financial statements.
F - 6
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
RECONCILIATION OF NET INCOME (LOSS) TO NET
CASH PROVIDED BY OPERATING ACTIVITIES
Net Income (Loss) $ 2,602 $ 18 $ (566)
Provision for Loan Losses 1,948 2,496 811
Gain on Sale of Securities Available-for-Sale (86) - -
(Gain) Loss on Sale of Premises and Equipment (36) 12 -
Common Stock Issued in Lieu of Subordinated
Debt Interest Payment - 67 -
Net Amortization 333 390 363
Depreciation 772 608 363
Deferred Income Taxes 167 47 (347)
Changes in Operating Assets and Liabilities -
Decrease (Increase) in -
Interest Receivable (95) (619) (672)
Other Assets (1,254) (531) (399)
Increase (Decrease) in -
Interest Payable (465) 460 859
Income Tax Payable (256) 130 -
Other Liabilities 240 140 (138)
-------------- -------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,870 3,218 274
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in Available-for-Sale Securities -
Sales 12,537 - 4,177
Maturities, Prepayments and Calls 18,734 7,307 2,279
Purchases (34,921) (24,094) (10,047)
Net Change in Interest-Bearing Deposits in Banks (1,895) - -
Proceeds from Sale of Premises and Equipment 35 7 -
Loan Originations and Principal Collections, net (36,480) (138,743) (82,582)
Additions to Premises and Equipment (2,468) (3,434) (1,719)
Net Cash (Paid) Acquired in Transaction Accounted for Under the
Purchase Method of Accounting 5,182 - (815)
-------------- -------------- --------------
NET CASH USED BY INVESTING ACTIVITIES (39,276) (158,957) (88,707)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase in Deposits 44,704 131,363 86,462
Net Increase (Decrease) in Federal Funds Purchased and Securities
Sold Under Agreements to Repurchase (9,806) 16,940 1,112
Proceeds from Issuance of Subordinated Debt - 2,250 -
Proceeds from Issuance of Common Stock 25,695 6,200 -
Net Advances from Federal Home Loan Bank 1,387 4,610 -
-------------- -------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 61,980 161,363 87,574
-------------- -------------- --------------
The accompanying notes are an integral part of the financial statements.
F - 7
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS $ 26,574 $ 5,624 $ (859)
CASH AND CASH EQUIVALENTS - beginning of period 17,899 12,275 13,134
-------------- ------------- --------------
CASH AND CASH EQUIVALENTS - end of period $ 44,473 $ 17,899 $ 12,275
============== ============= ==============
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES
Unrealized Appreciation of Securities, net of deferred taxes of
$156, $94 and $95 for 2002, 2001 and 2000, respectively $ 371 $ 136 $ 144
Conversion of Subordinated Debt to Common
Stock $ - $ 2,250 $ -
SUPPLEMENTAL SCHEDULE OF CASH FLOWS
Interest Paid $ 8,882 $ 9,256 $ 4,651
Income Taxes Paid $ 1,955 $ 399 $ -
ACQUISITION OF BANK
Interest-Bearing Deposits in Banks $ 1,811 $ - $ -
Loans 21,470 - 533
Investment Securities 13,123 - -
Premises and Equipment 1,469 - 777
Other Assets 872 - 5
Goodwill 1,424 - 973
Core Deposit Intangible 1,016 - -
Deposit Liabilities (45,902) - (1,167)
Other Liabilities (294) - (6)
Other Borrowings (171) - -
Deposit Paid in Prior Year - - (300)
-------------- ------------- --------------
NET CASH PAID (ACQUIRED) $ (5,182) $ - $ 815
============== ============= ==============
The accompanying notes are an integral part of the financial statements.
F - 8
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
First Security Group, Inc. (the Company) is a bank holding company organized for
the principal purpose of acquiring, developing and managing banks. The
accounting and reporting policies of the Company and its subsidiaries are in
accordance with accounting principles generally accepted in the United States of
America and conform to general practices within the banking industry.
The significant accounting policies and practices followed by the Company and
its subsidiaries are as follows:
BASIS OF CONSOLIDATION - The consolidated financial statements include the
accounts of First Security Group, Inc. and its wholly-owned subsidiaries, Dalton
Whitfield Bank, Frontier Bank and First State Bank (the Banks). All significant
intercompany balances and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS - The Company is headquartered in Chattanooga, Tennessee,
and provides banking services through the Banks to the various communities in
East Tennessee and North Georgia. The commercial banking operations are
primarily retail-oriented and aimed at individuals and small to medium-sized
local businesses. The Banks provide traditional banking services, which include
obtaining demand and time deposits and the making of secured and nonsecured
consumer loans and commercial loans.
BUSINESS COMBINATIONS - Statement of Financial Accounting Standards No. 141,
"Business Combinations" (SFAS 141) requires that all business combinations
initiated after June 30, 2001, be accounted for by the purchase method. Under
the purchase method, net assets of the acquired business are recorded at their
estimated fair values as of the date of acquisition with any excess of the cost
of the acquisition over the fair value of the net tangible and intangible assets
acquired recorded as goodwill. The Company typically provides an allocation
period, not to exceed one year, to identify and determine the fair values of the
assets acquired and liabilities assumed in business purchases. The Company
currently does not anticipate any material adjustments to the assigned values of
the assets and liabilities of any acquired banks. Results of operations of the
acquired business are included in the income statement from the date of
acquisition.
CASH AND CASH EQUIVALENTS - For the purpose of presentation in the statements of
cash flows, the Company considers all cash and amounts due from depository
institutions to be cash equivalents.
INTEREST-BEARING DEPOSITS IN BANKS - Interest-bearing deposits in banks mature
within one to four years and are carried at cost.
SECURITIES - Securities that management does not have the intent or ability to
hold to maturity are classified as available-for-sale and recorded at fair
value. Unrealized gains and losses are excluded from earnings and reported in
other comprehensive income. Purchase premiums and discounts are recognized in
interest income using methods approximating the interest method over the terms
of the securities. Gains and losses on sale of securities are determined using
the specific identification method.
LOANS - Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
principal adjusted for any charge-offs, the allowance for loan losses, and any
deferred fees or costs on originated loans.
F - 9
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
A loan is impaired when, based on current information and events, it is probable
that the Company will be unable to collect all amounts due according to the
contractual terms of the loan agreement. Impaired loans are measured based on
the present value of expected future cash flows discounted at the loan's
effective interest rate, or as a practical expedient, at the loan's observable
market price or the fair value of the collateral if the loan is
collateral-dependent. When the fair value of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a specific
reserve allocation which is a component of the allowance for loan and lease
losses.
Loans, including impaired loans, are generally classified as nonaccrual if they
are past due as to maturity or payment of principal or interest for a period of
more than 90 days, unless such loans are well collateralized and in the process
of collection. If a loan or a portion of a loan is classified as doubtful or is
partially charged off, the loan is generally classified as nonaccrual. At
management's discretion, loans that are on a current payment status or past due
less than 90 days may also be classified as nonaccrual if repayment in full of
principal and/or interest is in doubt.
LOAN ORIGINATION FEES - Loan origination fees and certain direct origination
costs are capitalized and recognized as an adjustment of the yield over the
lives of the related loans.
INTEREST INCOME ON LOANS - Interest on loans is accrued and credited to income
based on the principal amount outstanding. The accrual of interest on loans is
discontinued when, in the opinion of management, there is an indication that the
borrower may be unable to meet payments as they become due. Upon such
discontinuance, all unpaid accrued interest is reversed.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is increased by
charges to income and decreased by charge-offs (net of recoveries). Management's
periodic evaluation of the allowance is based on the Banks' past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower's ability to repay, the estimated value of any
underlying collateral and current economic conditions. Any difference between
the loan's fair value and carrying amount is recorded as a reserve for loan
losses. Although management uses available information to recognize losses on
loans, because of uncertainties associated with local economic conditions,
collateral values and future cash flows on impaired loans, it is reasonably
possible that a material change could occur in the allowance for loan losses in
the near term. However, the amount of the change that is reasonably possible
cannot be estimated.
The allowance for loan losses reflects management's assessment and estimate of
the risks associated with extending credit and its evaluation of the quality of
the loan portfolio. The Company periodically analyzes the commercial loan
portfolio in an effort to establish an allowance for loan losses that it
believes will be adequate in light of anticipated risks and loan losses. In
assessing the adequacy of the allowance, the Company reviews the size, quality
and risk of loans in the portfolio. The Company also, on at least a quarterly
basis, considers such factors as:
- - the Bank's loan loss experience;
- - the amount of past due and nonperforming loans;
- - specific known risks;
- - the status and amount of past due and nonperforming assets;
- - underlying estimated values of collateral securing loans;
- - current economic conditions; and
- - other factors which management believes affects the allowance for potential
credit losses.
F - 10
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
An analysis of the credit quality of the loan portfolio and the adequacy of the
allowance for loan losses is prepared by the Banks and is presented to the
respective boards of directors on a regular basis.
PREMISES AND EQUIPMENT - Land is carried at cost. Premises and equipment are
stated at cost less accumulated depreciation. Expenditures for repairs,
maintenance and minor improvements are charged to expense as incurred and
additions and improvements that significantly extend the lives of assets are
capitalized. Upon sale or other retirement of depreciable property, the cost and
related accumulated depreciation are removed from the related accounts and any
gain or loss is reflected in operations.
Depreciation is provided using the straight-line method over the estimated lives
of the depreciable assets. Deferred income taxes are provided for differences in
the computation of depreciation for book and tax purposes.
GOODWILL AND OTHER INTANGIBLE ASSETS - Goodwill represents the cost in excess of
the fair value of the net assets acquired. Other intangible assets represent
premiums paid for acquisitions of core deposits (core deposit intangibles) and
are included in other assets. On January 1, 2002, the Company adopted Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets," (SFAS 142). Under the new standard, goodwill, including that acquired
before initial application of the standard, will no longer be amortized but will
be tested for impairment at least annually, beginning in the year of adoption.
Identified finite-lived intangible assets will be amortized over their useful
lives and reviewed for impairment when circumstances warrant. Core deposit
intangibles are being amortized on an accelerated basis over 10 years. Prior to
the adoption of SFAS 142, the Company's goodwill was amortized on the
straight-line basis over a period of 15 years.
INCOME TAXES - Deferred tax assets and liabilities are reflected at currently
enacted income tax rates applicable to the period in which the deferred tax
assets or liabilities are expected to be realized or settled. As changes in tax
laws or rates are enacted, deferred tax assets and liabilities are adjusted
through the provision for income taxes.
FINANCIAL INSTRUMENTS - In the ordinary course of business the Company has
entered into off-balance-sheet financial instruments consisting of commitments
to extend credit, commercial letters of credit and standby letters of credit.
Such financial instruments are recorded in the financial statements when they
are funded or related fees are incurred or received.
ADVERTISING COSTS - Advertising costs are charged to expense when incurred.
STOCK-BASED COMPENSATION - The Company accounts for its stock-based compensation
plans using the accounting method prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees." Since the Company is
not required to adopt the fair value based recognition provisions prescribed
under Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," it has elected only to comply with the disclosure
requirements set forth in the statement, which include disclosing pro forma net
income as if the fair value based method of accounting had been applied.
F - 11
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
ESTIMATES AND UNCERTAINTIES - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
PER SHARE DATA - Basic net income (loss) per share represents net income (loss)
divided by the weighted average number of shares outstanding during the period.
Diluted net income (loss) per share reflects additional shares that would have
been outstanding if dilutive potential shares had been issued, as well as any
adjustment to income that would result from the assumed issuance.
COMPREHENSIVE INCOME - Accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income. Although certain
changes in assets and liabilities, such as unrealized gains and losses on
available-for-sale securities, are reported as a separate component of the
equity section of the balance sheet, such items, along with net income, are
components of comprehensive income.
SEGMENT REPORTING - Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" provides
for the identification of reportable segments on the basis of discreet business
units and their financial information to the extent such units are reviewed by
an entity's chief decision maker (which can be an individual or group of
management persons). The statement permits aggregation or combination of
segments that have similar characteristics. In the Company's operations, each
bank or branch is viewed by management as being a separately identifiable
business or segment from the perspective of monitoring performance and
allocation of financial resources. Although the Banks and branches operate
independently and are managed and monitored separately, each is substantially
similar in terms of business focus, type of customers, products and services.
Further, the Banks and the Company are subject to substantially similar laws and
regulations unique to the banking industry. Accordingly, the Company's
consolidated financial statements reflect the presentation of segment
information on an aggregated basis in one reportable segment.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - The Company currently does not
have any derivative instruments that require fair value measurement under
generally accepted accounting principles.
RECLASSIFICATIONS - Certain reclassifications have been made to the prior years'
financial statements to conform to the current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS - In June 2001, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations." This statement addresses
financial and reporting obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
acquisition, construction, development and/or the normal operation of a
long-lived asset, except for certain obligations of lessees. The provisions of
this statement are effective for the Company beginning January 1, 2003 and its
adoption is not expected to have a material impact on the Company's results of
operations or its financial position.
F - 12
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
In August 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 144 (SFAS 144), "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," and Accounting Principles Board Opinion No. 30,
"Reporting Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." This statement retains the fundamental provisions of
SFAS 121 for recognition and measurement of impairment, but amends the
accounting and reporting standards for segments of a business to be disposed of.
The provisions of this statement were adopted by the Company on January 1, 2002
and did not have a material impact on the Company's results of operations or its
financial position.
In April 2002, the Financial Accounting Standards Board issued Statement No.
145, (SFAS 145), "Rescission of Financial Accounting Standards Board Statements
No. 4, 44, and 64, Amendment of Financial Accounting Standards Board Statement
No. 13, and Technical Corrections." SFAS 145 rescinds Statement 4, which
required all gains and losses from extinguishment of debt to be aggregated and,
if material, classified as an extraordinary item, net of related income tax
effect. As a result, the criteria in Opinion 30 will not be used to classify
those gains and losses. SFAS 145 also amends Statement 13 to require that
certain lease modifications that have economic effects similar to sale-leaseback
transactions be accounted for in the same manner as sale-leaseback transactions.
This statement also makes technical corrections to existing pronouncements.
Certain provisions of this statement will become effective on January 1, 2003,
while other provisions became effective for transactions occurring and financial
statements issued after May 15, 2002. Adoption of the provisions of this
statement that were effective after May 15, 2002, did not have a material impact
on the Company's results of operations or its financial position. Adoption of
the remaining provisions of SFAS 145 is not expected to have a material impact
on the Company's results of operations or its financial position.
In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" (SFAS 146). SFAS 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities. SFAS 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized and measured initially at fair value only when the
liability is incurred. The accounting for similar events and circumstances will
be the same. This statement is effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged. The
effect of adoption of SFAS 146 is not expected to have a material effect on the
Company's results of operations or its financial position.
F - 13
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - continued
In October 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 147, (SFAS 147), "Acquisitions of Certain
Financial Institutions-an amendment of Financial Accounting Standards Board
Statements No. 72 and 144 and Financial Accounting Standards Board
Interpretation No. 9." SFAS 147 removes acquisitions of financial institutions
from the scope of both Statement 72 and Interpretation 9 and requires that those
transactions be accounted for in accordance with Financial Accounting Standards
Board Statements No. 141, "Business Combinations," and SFAS 142. As a result,
the requirement in Statement 72 to recognize (and subsequently amortize) any
excess of the fair value of liabilities assumed over the fair value of tangible
and identifiable assets no longer applies to acquisitions within the scope of
this statement. SFAS 147 also amends Financial Accounting Standards Board
Statement No. 144, (SFAS 144), "Accounting for the Impairment or Disposal of
Long-Lived Assets," to include in its scope long-term customer-relationship
intangible assets of financial institutions. Thus, those intangible assets are
subject to the same undiscounted cash flow recoverability test and impairment
loss recognition and measurement provisions that SFAS 144 requires for other
long-lived assets that are held and used. Provisions of this statement became
effective on October 1, 2002. The effect of adoption of SFAS 147 did not have a
material effect on the Company's results of operations or its financial position
since the Company was already accounting for its acquired intangible assets in
accordance with the guidance of SFAS 141 and 142.
In December 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 148, (SFAS 148), "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123 " SFAS 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," (SFAS 123) to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The
provisions of this statement were effective December 31, 2002. As the Company
continues to account for stock-based compensation under the guidance of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," the transition rules of this standard did not have a material effect
on the Company's results of operations or its financial position.
In 2002, the Financial Accounting Standards Board issued Financial Accounting
Standards Board Interpretation No. 45, (FIN 45), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others - an Interpretation of FASB Statements No. 5, 57 and 107
and Rescission of FASB Interpretation No. 34." FIN 45 elaborates on the
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations 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. FIN 45 does not prescribe a specific approach for
subsequently measuring the guarantor's recognized liability over the term of the
related guarantee. FIN also incorporates, without change, the guidance in FASB
Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others," which is being superseded. The initial recognition and initial
measurement provisions of FIN 45 are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002, regardless of the
guarantor's fiscal year-end and are not expected to have a material impact on
the Company's results of operations or its financial position. The disclosure
requirements of FIN 45 are effective for financial statements of interim or
annual periods ending after December 15, 2002.
F - 14
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - BUSINESS COMBINATIONS
On July 20, 2002, the Company acquired 100% of the outstanding common shares of
First State Bank. The results of First State Bank's operations have been
included in the consolidated financial statements since that date. First State
Bank is a Tennessee state chartered, FDIC insured, commercial bank in
Maynardville, Tennessee, and is now operated as a wholly-owned subsidiary of the
Company. As of the acquisition date, First State Bank's leverage capital ratio
was approximately 12.3% and its liquidity ratio exceeded 60%, which will allow
the Company to enhance earnings by increasing the Bank's asset base and changing
its mix of earning assets in favor of higher yielding loans. The acquisition
assists the Company in its plan to increase earning assets by branching into
nearby Knox and Jefferson Counties.
The aggregate purchase price was $8,604 thousand, all of which was paid in cash.
The purchase price included $8,166 thousand to First State Bank's shareholders
and $438 thousand in acquisition costs, such as legal, accounting and investment
banking fees. The transaction resulted in $1,425 thousand of goodwill and $1,016
thousand of core deposit intangibles. The amount allocated to the core deposit
intangible was determined by an independent valuation and is being amortized
over the estimated useful life of ten years using an accelerated basis
reflecting the pattern of the expected run off of the related deposits.
The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of the acquisition:
(in thousands)
Cash and Due from Banks $ 2,194
Federal Funds Sold and Securities Purchased
Under Agreements to Resell 11,592
---------------
Cash and Cash Equivalents 13,786
---------------
Interest-Bearing Deposits in Banks 1,811
---------------
Securities Available for Sale 13,123
---------------
Loans 21,847
Less: Allowance for Loan Losses 377
---------------
Net Loans 21,470
---------------
Premises and Equipment, net 1,469
---------------
Intangible Assets 1,016
---------------
Goodwill (Nondeductible) 1,424
---------------
Other Assets 872
---------------
Total Assets Acquired 54,971
---------------
Deposits (45,902)
Other Borrowings (171)
Other Liabilities (294)
---------------
Total Liabilities Assumed (46,367)
---------------
Net Assets Acquired $ 8,604
===============
F - 15
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - BUSINESS COMBINATIONS - continued
The following table presents unaudited proforma results of operations as though
the acquisition had been completed at the beginning of the years presented:
Year Ended Year Ended
December 31, December 31,
2002 2001
(in thousands, except per share data)
Interest Income $ 27,152 $ 23,712
Interest Expense 8,943 11,049
------------- -------------
Net Interest Income 18,209 12,663
Provision for Loan Losses 1,948 2,528
------------- -------------
Net Interest Income After Provision for Loan Losses 16,261 10,135
Noninterest Income 3,936 2,967
Noninterest Expense 15,914 12,781
------------- -------------
Income Before Income Taxes 4,283 321
Income Tax Provision 1,651 278
------------- -------------
Net Income $ 2,632 $ 43
============= =============
Net Income Per Share
Basic $ 0.40 $ 0.01
Diluted $ 0.40 $ 0.01
On June 24, 2000, the Company acquired First Central Bank of Monroe County,
Sweetwater, Tennessee from First Central Bancshares, Inc. of Lenoir City,
Tennessee. The total purchase price of $2,288 thousand including the assumption
of liabilities exceeded the total estimated fair value of the assets acquired by
$973 thousand. The excess purchase price was assigned to goodwill and was being
amortized on a straight-line basis over an estimated life of fifteen years prior
to January 1, 2002. Upon acquisition by the Company, the state chartered savings
bank was converted to a state chartered commercial bank and the name was changed
to Frontier Bank and the bank's headquarters was moved to Chattanooga,
Tennessee. Operations of the Sweetwater branch have been included in operations
of the Company since the date of acquisition. Subsequent to this acquisition,
Frontier Bank opened a branch in Athens, Tennessee, a branch in Lenoir City,
Tennessee, six branches in the Chattanooga, Tennessee metropolitan area, and a
loan production office in Loudon, Tennessee. Frontier Bank's branches in
Sweetwater, Athens and Lenoir City, Tennessee do business as First Security
Bank.
F - 16
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - BUSINESS COMBINATIONS - continued
PLANNED MERGER
Effective November 19, 2002, the Company entered into a merger agreement with
Premier National Bank of Dalton (Premier), a national bank with two branches
located in Dalton, Georgia. The merger agreement provides that Premier will
merge with and into Dalton Whitfield Bank, with Dalton Whitfield being the
surviving bank. Pursuant to the merger agreement, each issued and outstanding
share of common stock of Premier will be exchanged for 0.425 shares of common
stock of the Company. As of December 31, 2002, Premier had assets of
approximately $85 million, deposits of approximately $73 million, shareholders'
equity of approximately $7 million and approximately 2.7 million shares of
common stock outstanding. The Company anticipates consummating the transaction
in the first quarter of 2003.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities, with gross unrealized gains and
losses, are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------
(in thousands)
Securities Available-for-Sale
December 31, 2002
Debt Securities -
Federal Agencies $ 19,239 $ 434 $ - $19,673
Mortgage-Backed 21,572 493 - 22,065
Municipals 12,728 117 141 12,704
---------- ----------- ----------- -------
$ 53,539 $ 1,044 $ 141 $54,442
========== =========== =========== =======
December 31, 2001
Debt Securities -
Federal Agencies $ 21,877 $ 359 $ 118 $22,118
Mortgage-Backed 14,798 229 90 14,937
Municipals 236 - 4 232
---------- ----------- ----------- -------
$ 36,911 $ 588 $ 212 $37,287
========== =========== =========== =======
At December 31, 2002 and 2001, federal agencies and mortgage-backed securities
with a carrying value of $5,620 thousand and $11,719 thousand, respectively
were pledged to secure public deposits. At December 31, 2002 and 2001, the
carrying amount of securities pledged to secure repurchase agreements was
$17,597 thousand and $11,817 thousand, respectively.
F - 17
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES - continued
The amortized cost and fair value of debt securities by contractual maturity at
December 31, 2002, are as follows:
Amortized Fair
Cost Value
(in thousands)
Within 1 Year $ 4,602 $ 4,627
Over 1 Year through 5 Years 15,517 15,862
5 Years to 10 Years 8,948 9,096
Over 10 Years 2,900 2,792
---------- -------
31,967 32,377
Mortgage-Backed Securities 21,572 22,065
---------- -------
$ 53,539 $54,442
========== =======
Proceeds from sales of securities available-for-sale totaled $12,537 thousand
for the year ended December 31, 2002. Gross unrealized gains and losses from
sales of securities available-for-sale were not significant for the year ended
December 31, 2002. There were no sales for the year ended December 31, 2001.
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans by type are summarized as follows:
December 31,
2002 2001
(in thousands)
Loans Secured by Real Estate -
Residential 1-4 Family $ 87,923 $ 60,500
Commercial 55,157 52,395
Construction 28,701 18,923
Other 2,123 1,861
--------- ---------
173,904 133,679
Commercial Loans 108,761 97,238
Consumer Installment Loans 64,771 59,593
Other 1,146 533
--------- ---------
Total Loans 348,582 291,043
Allowance for Loan Losses (5,362) (3,825)
--------- ---------
Net Loans $343,220 $287,218
========= =========
F - 18
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES - continued
An analysis of the allowance for loan losses follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
Allowance for Loan Losses -
beginning of year $ 3,825 $ 1,942 $ 1,057
Additions due to Business Combinations 377 - 94
Provision for Loan Losses 1,948 2,496 811
Loans Charged Off (868) (622) (24)
Recoveries of Loans 80 9 4
-------------- -------------- --------------
Allowance for Loan Losses - end of year $ 5,362 $ 3,825 $ 1,942
============== ============== ==============
Impaired loans, which are recognized in conformity with FASB Statement No. 114
as amended by FASB No. 118, as well as nonaccrual loans and loans past due 90
days or more and still accruing interest as of December 31, 2002 and 2001 were
not significant. The Company had no significant outstanding commitments to lend
additional funds to customers whose loans have been placed on nonaccrual status.
Because of uncertainties inherent in the estimation process, management's
estimate of credit losses in the loan portfolio and the related allowance may
change in the near term. However, the amount of the change that is reasonably
possible cannot be estimated.
The Banks have entered into transactions with certain directors, executive
officers and significant shareholders and their affiliates. Such transactions
were made in the ordinary course of business on substantially the same terms and
conditions, including interest rates and collateral, as those prevailing at the
same time for comparable transactions with other customers, and did not, in the
opinion of management, involve more than normal credit risk or present other
unfavorable features. The aggregate amount of loans to such related parties at
December 31, 2002 and 2001 was $3,359 thousand and $2,027 thousand,
respectively. New loans made to such related parties amounted to $3,235 thousand
and payments amounted to $1,903 thousand for 2002. For 2001, new loans amounted
to $3,291 thousand and payments amounted to $1,987 thousand.
NOTE 5 - PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
December 31,
2002 2001
(in thousands)
Land $ 4,475 $ 3,315
Buildings and Improvements 5,930 4,440
Equipment 4,315 3,080
-------- --------
14,720 10,835
Accumulated Depreciation (1,725) (1,006)
-------- --------
$12,995 $ 9,829
======== ========
F - 19
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - GOODWILL
The changes in the carrying amounts of goodwill are as follows:
Year Ended Year Ended
December 31, December 31,
2002 2001
(in thousands)
Balance - beginning of year $ 6,193 $ 6,674
Goodwill acquired 1,424 -
Amortization Expense - (481)
------------- --------------
Balance - end of year $ 7,617 $ 6,193
============= ==============
The following tables present actual results for the year ended December 31,
2002, and adjusted net income (loss) and net income (loss) per share for the
years ended December 31, 2001 and 2000, respectively, assuming the
nonamortization provisions of SFAS No. 142 were effective at the beginning of
the years presented.
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands, except per share amounts)
Reported net income (loss) $ 2,602 $ 18 $ (566)
Add back: Goodwill, amortization, net of tax - 298 275
------------- ------------- --------------
Adjusted net income (loss) $ 2,602 $ 316 $ (291)
============= ============= ==============
Basic net income (loss) per share:
Reported net income (loss) $ 0.40 $ - $ (0.14)
Goodwill amortization - 0.07 0.07
------------- ------------- --------------
Adjusted net income (loss) $ 0.40 $ 0.07 $ (0.07)
============= ============= ==============
Diluted net income (loss) per share:
Reported net income (loss) $ 0.39 $ - $ (0.14)
Goodwill amortization - 0.07 0.07
------------- ------------- --------------
Adjusted net income (loss) $ 0.39 $ 0.07 $ (0.07)
============= ============= ==============
F - 20
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - DEPOSITS
Scheduled maturities of certificates of deposit as of December 31, 2002, are as
follows:
(in thousands)
2003 $ 152,080
2004 26,677
2005 6,002
2006 2,063
2007 and thereafter 6,066
---------------
$ 192,888
===============
NOTE 8 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase represent the purchase of
interests in securities by commercial checking customers which are repurchased
by the Banks on the following business day. The pledged securities are held in
safekeeping for the Banks and had a carrying value of approximately $17,597
thousand and $11,817 thousand at December 31, 2002 and 2001, respectively. These
agreements averaged $12,484 thousand and $7,266 thousand during 2002 and 2001,
respectively. The maximum amounts outstanding at any month end during 2002 and
2001 were $15,296 thousand and $9,369 thousand, respectively. Interest expense
on repurchase agreements totaled $186 thousand, $247 thousand and $125 thousand
for the years ended 2002, 2001 and 2000.
NOTE 9 - OTHER BORROWINGS
Other borrowings at December 31, 2002, consist of long-term, fixed-rate advances
from the Federal Home Loan Bank (FHLB), totaling $6,000 thousand and a mortgage
note totaling $168 thousand. Other borrowings at December 31, 2001, consisted
of 1.9% 90-day advances from the FHLB which totaled $4,610 thousand and were
replaced by the long-term, fixed-rate advances during 2002. Pursuant to the
blanket agreement for advances and security agreement with FHLB Cincinnati,
advances are secured by Frontier Bank's unencumbered qualifying mortgage loans
equal to at least 135% of outstanding advances. Advances are also secured by
FHLB stock owned by the Banks. As of December 31, 2002 and 2001, the Banks had
loans totaling $19,330 thousand and $18,822 thousand, respectively, pledged as
collateral at FHLBs.
As a member of FHLB Atlanta, Dalton Whitfield Bank must own FHLB stock equal to
the greater of 1% of mortgage assets or .3% of total assets. As a member of FHLB
Cincinnati, Frontier Bank must own FHLB stock equal to the greater of $500 or 1%
of mortgage assets. Also, members at either branch of FHLB may be required to
own additional FHLB stock to ensure their stock balance is equal to or greater
than 5% of outstanding advances. At December 31, 2002 and 2001, the Company
owned FHLB stock totaling $920 thousand and $434 thousand, respectively.
At December 31, 2002, the Company had lines of credit totaling $32,500 thousand
with correspondent banks for short-term liquidity needs and approximately $4,300
thousand available with FHLB. At December 31, 2002, the Company also had an
FHLB letter of credit totaling $4,000 thousand.
F - 21
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - OTHER BORROWINGS - continued
The maturity and weighted average interest rates of FHLB advances are as
follows:
Amount
(in thousands) Rate
2003 $ 2,000 3.63 %
2004 2,000 4.38 %
2005 2,000 4.92 %
---------------
$ 6,000
===============
NOTE 10 - COMMON STOCK DATA
The basic and diluted net income per share calculations are as follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
Numerator
Net Income for Calculating Diluted
Net Income per Share $ 2,602 $ 18 $( 566)
============= ============= ====================
Denominator
Weighted-Average Common Shares for
Calculating Basic Net Income per Share 6,538 4,354 4,106
Effect of Dilutive Securities:
Stock Options (as determined by application of
the treasury stock method) 82 75 -
------------- ------------- --------------------
Weighted-Average Common Shares for
Calculating Diluted Net Income per Share 6,620 4,429 4,106
============= ============= ====================
Basic Net Income (Loss) per Share $ 0.40 $ - $( 0.14)
Diluted Net Income (Loss) per Share $ 0.39 $ - $( 0.14)
On March 2, 2001, the Company's Board of Directors approved a 13-for-10 stock
split effected in the form of a dividend on April 15, 2001 to holders of record
on March 31, 2001. All share and per share information of the Company has been
restated to reflect the stock split.
F - 22
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMON STOCK DATA - continued
Options to purchase 151 thousand and 20 thousand shares of common stock were
outstanding during 2002 and 2001, respectively, at $10 per share but were not
included in the computation of diluted earnings per share because the options'
exercise price was equal to the average market price of the common shares. The
options expire in 2012 and 2011. 149 thousand and 20 thousand options to
purchase shares of common stock were outstanding at December 31, 2002 and 2001,
respectively.
6% Subordinated Mandatory Convertible Notes in the principal amount of $2,250
thousand were outstanding from April 15, 2001 through October 15, 2001, at which
time the principal plus interest converted into 232 thousand shares of the
Company's common stock. These shares were antidilutive and excluded from the
computation of dilutive earnings per share.
On June 14, 2001, the Company's non-underwritten public offering of up to
$30,000 thousand in shares of the Company's common stock at a price of $10 per
share became effective. The Company sold 665 thousand shares in the offering
during December, 2001.
On March 19, 2002, the Company's non-underwritten private placement of up to
$20,000 thousand in shares of the Company's common stock at a price of $10 per
share became effective. Subsequently, the private placement was increased to
$27,500 thousand. The private placement closed on August 8, 2002, by which time
the Company had sold 2,576 thousand shares.
NOTE 11 - LEASES
The Company leases bank branches and the corporate office and equipment under
operating lease agreements. Minimum lease commitments with remaining
noncancelable lease terms in excess of one year as of December 31, 2002, are as
follows:
(in thousands)
Year Ending
December 31, 2003 $ 526
December 31, 2004 361
December 31, 2005 315
December 31, 2006 291
December 31, 2007 289
Thereafter 725
---------------
$ 2,507
===============
Rent expense totaled $515 thousand, $497 thousand and $245 thousand for the
years ended 2002, 2001 and 2000.
F - 23
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - INCOME TAXES
The income tax provision consists of the following:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
Current Provision $ 1,391 $ 188 $ -
Deferred Provision (Benefit) 167 47 (347)
------------- ------------- --------------
Income Tax Provision (Benefit) $ 1,558 $ 235 $ (347)
============= ============= ==============
Reconciliation of the income tax provision (benefit) to statutory rates is as
follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
Federal Taxes at Statutory Tax Rate $ 1,414 $ 86 $ (310)
Underaccrual of Prior Year Taxes and Other - 125 -
Other, net (14) - -
State Taxes, net of federal effect 158 24 (37)
-------------- ------------- --------------
Income Tax Provision (Benefit) $ 1,558 $ 235 $ (347)
============== ============= ==============
Deferred tax assets included in other assets consist of the following:
December 31,
2002 2001
(in thousands)
Deferred Tax Assets
Organization and Start-up Costs $ 81 $ 116
Allowance for Loan Losses 1,393 1,271
Goodwill - 94
Deferred Loan Fees 91 78
Other 31 -
------ ------
1,596 1,559
------ ------
Deferred Tax Liabilities
Securities Available-for-Sale 308 152
Premises and Equipment 773 540
Goodwill 59 -
------ ------
1,140 692
------ ------
Net Deferred Tax Assets $ 456 $ 867
====== ======
F - 24
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - INCOME TAXES - continued
The Company has evaluated the available evidence supporting the future
realization of its gross deferred tax assets of $456 thousand at December 31,
2002, including the amount and timing of future taxable income, and has
determined that it is more likely than not that the assets will be realized.
NOTE 13 - 401(K) AND EMPLOYEE STOCK OWNERSHIP PLAN
The Company has a 401(k) and employee stock ownership plan (the plan) covering
employees meeting certain age and service requirements. Employees may contribute
up to 15% of their compensation subject to certain limits based on federal tax
laws. The Company makes matching contributions equal to 25% of the employee's
contribution up to 6% of the employee's compensation. In its sole discretion at
the end of the plan year, the Company may make an additional contribution up to
6% of the employee's compensation for the plan year.
Under the employee stock ownership portion (ESOP) of the plan, the Company may
make discretionary profit sharing contributions to the ESOP. The ESOP
contribution shall be used to repay any acquisition loan and any financed shares
which are available for allocation to participants. Financed shares acquired
will be released in accordance with the plan and allocated to the ESOP accounts
of participants at the end of each plan year. Stock dividends paid on shares of
Company stock shall be allocated to the participants' ESOP accounts, while cash
dividends on allocated and financed shares shall be used to repay the
acquisition loan. The ESOP has no borrowing at December 31, 2002.
During 2002, the plan was amended to reflect the transfer of assets from First
State Bank Financial Security Plan into the plan and add First State Bank as an
affiliated employer in addition to other changes.
Compensation expense for the 401(k) portion of the plan was $174 thousand, $125
thousand and $67 thousand for 2002, 2001 and 2000, respectively.
NOTE 14 - LONG-TERM INCENTIVE PLAN
The 2002 Long-Term Incentive Plan (2002 LTIP), was approved by the shareholders
of the Company at the 2002 annual meeting. Eligible participants include
eligible employees, officers, consultants and directors of the Company or any
affiliate. Pursuant to the 2002 LTIP, the total number of shares of stock
reserved and available for awards is 200 thousand, of which not more than 20%
may be granted as awards of restricted stock. The exercise price per share of a
stock option granted may not be less than the fair market value as of the grant
date. The exercise price must be at least 110% of of the fair market value at
the grant date for options granted to individuals, who at grant date, are 10%
owners of the Company's voting stock (10% owner). Restricted stock may be
awarded to participants with terms and conditions determined by the committee
appointed by the board (the committee) for administering the 2002 LTIP. The
term of each award is determined by the committee, provided that the term of any
incentive stock option may not exceed ten years (five years for 10% owners) from
its grant date.
F - 25
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - LONG-TERM INCENTIVE PLAN - continued
The Company's 1999 Long-Term Incentive Plan (1999 LTIP) included eligible
employees. The total number of shares of stock reserved and available for awards
was 650 thousand, of which not more than 10% could be granted as awards of
restricted stock. Under the terms of the plan, incentive stock options to
purchase shares of the Company's common stock were granted at a price not less
than the fair market value of the stock as of the date of the grant. Options
were to be exercised within ten years from the date of grant subject to
conditions specified by the plan. Restricted stock could also be awarded by the
committee in accordance with the 1999 LTIP. Each award vested in approximately
equal percentages each year over a period of not less than three years from the
date of grant as determined by the committee subject to accelerated vesting
under terms of the 1999 LTIP or as provided in any award agreement.
No options or restricted stock were awarded as of December 31, 2000.
Following is a summary of the status of the stock options as of December 31,
2002 and 2001, and changes during the years then ended:
December 31, 2002 December 31, 2001
Weighted Weighted
Number of Average Number of Average
Shares Exercise Price Shares Exercise Price
(in thousands) (in thousands)
Outstanding - beginning of year 377 $ 7.81 - $ -
Granted 131 10.00 381 7.81
Forfeited (11) 8.17 (4) 7.69
---------- ----------
Outstanding - end of year 497 8.38 377 7.81
========== ==========
Options Exercisable - end of year 123 $ 7.80 - N/A
Weighted Average Fair Value of Options
Granted During the Year $ 2.42 $ 2.40
Following is a summary of the status of stock options outstanding at December
31, 2002:
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Number of Remaining Average Number Average
Exercise Price Range Shares Contractual Life Exercise Price Exercisable Exercise Price
(in thousands) (in thousands)
7.69-$10.00 497 8.5 years $ 8.38 123 $ 7.80
F - 26
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - LONG-TERM INCENTIVE PLAN - continued
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" in accounting for the stock options. Accordingly, no
compensation expense has been recognized for the plan. Had compensation cost for
the plan been determined based on the fair value at the grant date consistent
with SFAS No. 123, "Accounting for Stock-Based Compensation," net income and
earnings per share would have been reduced to the pro forma amounts indicated in
the table below.
Year Ended Year Ended
December 31, December 31,
2002 2001
(in thousands, except per share data)
Net Income (Loss)
As Reported $ 2,602 $ 18
Pro forma $ 2,418 $ (169)
Basic Net Income (Loss) per Share
As Reported $ 0.40 $ -
Pro forma $ 0.37 $ (0.04)
Diluted Net Income (Loss) per Share
As Reported $ 0.39 $ -
Pro forma $ 0.37 $ (0.04)
The fair value of options at date of grant was estimated by management using the
Black-Scholes option pricing model with the following assumptions used for
grants:
December 31,
2002 2001
Dividend Yield 1.00 % 1.00 %
Average Risk-Free Interest Rate 3.58 % 5.08 %
Expected Life 7 years 7 years
Expected Volatility 15 % 20 %
NOTE 15 - MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company (on a consolidated basis) and the Banks are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can result in certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's and the Banks' financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and the Banks 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 judgements by the regulators about components, risk weightings and
other factors. Prompt corrective action provisions are not applicable to bank
holding companies.
F - 27
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - MINIMUM REGULATORY CAPITAL REQUIREMENTS - continued
Frontier Bank is required to maintain a Tier 1 capital to assets leverage ratio
of not less than 8% during the first three years of operations. Frontier Bank
may not pay any dividends for the first three years of operations without prior
written approval from the applicable regulatory authority.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Banks to maintain minimum amounts and ratios (set
forth in the following table) 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 the average assets (as defined). Management believes, as of December
31, 2002, that the Company and the Banks met all capital adequacy requirements
to which they are subject.
As of December 31, 2002, the Banks were well capitalized for regulatory
purposes. To be categorized as well capitalized, the Company and the Banks must
maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios
as set forth in the following table. Until the Company had consolidated assets
of $150 million or more, the Federal Reserve did not consider the Company's
capital adequacy. Since reaching $150 million in consolidated assets in July of
2000, the Company has been required to maintain the following consolidated
capital requirements to be considered "well capitalized."
Minimum To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirements Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
December 31, 2002
Total Capital to Risk-Weighted Assets -
First Security Group, Inc. and subsidiaries $63,303 17.6 % $28,714 8.0 % N/A N/A
Dalton Whitfield Bank $16,591 12.3 % $10,773 8.0 % $13,467 10.0 %
Frontier Bank $23,911 12.3 % $15,589 8.0 % $19,486 10.0 %
First State Bank $11,096 38.2 % $ 2,322 8.0 % $ 2,903 10.0 %
Tier 1 Capital to Risk-Weighted Assets -
First Security Group, Inc. and subsidiaries $58,806 16.4 % $14,357 4.0 % N/A N/A
Dalton Whitfield Bank $14,905 11.1 % $ 5,387 4.0 % $ 8,080 6.0 %
Frontier Bank $21,467 11.0 % $ 7,794 4.0 % $11,692 6.0 %
First State Bank $10,734 37.0 % $ 1,161 4.0 % $ 1,742 6.0 %
Tier 1 Capital to Average Assets -
First Security Group, Inc. and subsidiaries $58,806 12.6 % $18,710 4.0 % N/A N/A
Dalton Whitfield Bank $14,905 8.3 % $ 7,198 4.0 % $ 8,997 5.0 %
Frontier Bank $21,467 9.2 % $ 9,354 4.0 % $11,692 5.0 %
First State Bank $10,734 19.9 % $ 2,159 4.0 % $ 2,699 5.0 %
F - 28
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - MINIMUM REGULATORY CAPITAL REQUIREMENTS - continued
Minimum To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirements Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
December 31, 2001
Total Capital to Risk-Weighted Assets -
First Security Group, Inc. and subsidiaries $36,667 12.2 % $23,936 8.0 % N/A N/A
Dalton Whitfield Bank $15,047 11.9 % $10,123 8.0 % $12,653 10.0 %
Frontier Bank $19,227 11.1 % $13,815 8.0 % $17,269 10.0 %
Tier 1 Capital to Risk-Weighted Assets -
First Security Group, Inc. and subsidiaries $32,848 11.0 % $11,968 4.0 % N/A N/A
Dalton Whitfield Bank $13,464 10.6 % $ 5,061 4.0 % $ 7,592 6.0 %
Frontier Bank $17,120 9.9 % $ 6,907 4.0 % $10,361 6.0 %
Tier 1 Capital to Average Assets -
First Security Group, Inc. and subsidiaries $32,848 9.9 % $13,353 4.0 % N/A N/A
Dalton Whitfield Bank $13,464 9.1 % $ 5,928 4.0 % $ 7,409 5.0 %
Frontier Bank $17,120 9.2 % $ 7,425 4.0 % $ 9,281 5.0 %
Minimum To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirements Action Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in thousands)
December 31, 2000
Total Capital to Risk-Weighted Assets -
First Security Group, Inc. and subsidiaries $25,030 15.1 % $13,247 8.0 % N/A N/A
Dalton Whitfield Bank $10,216 11.0 % $ 7,409 8.0 % $ 9,261 10.0 %
Frontier Bank $14,452 19.9 % $ 5,809 8.0 % $ 7,261 10.0 %
Tier 1 Capital to Risk-Weighted Assets -
First Security Group, Inc. and subsidiaries $23,088 13.9 % $ 6,623 4.0 % N/A N/A
Dalton Whitfield Bank $ 9,124 9.9 % $ 3,704 4.0 % $ 5,557 6.0 %
Frontier Bank $13,602 18.7 % $ 2,904 4.0 % $ 4,356 6.0 %
Tier 1 Capital to Average Assets -
First Security Group, Inc. and subsidiaries $23,088 12.8 % $ 7,196 4.0 % N/A N/A
Dalton Whitfield Bank $ 9,124 8.4 % $ 4,360 4.0 % $ 5,450 5.0 %
Frontier Bank $13,602 19.2 % $ 2,836 4.0 % $ 3,544 5.0 %
F - 29
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are as follows:
December 31, 2002 December 31, 2001
Carrying Fair Carrying Fair
Amount Value Amount Value
(in thousands) (in thousands)
Financial Assets
Cash and Cash Equivalents $ 44,473 $ 44,473 $ 17,899 $ 17,899
Interest-Bearing Deposits in Banks $ 3,706 $ 3,706 $ - $ -
Securities Available-for-Sale $ 54,442 $ 54,442 $ 37,287 $ 37,287
Loans $ 348,582 $361,541 $ 291,043 $301,274
Allowance for Loan Losses $ 5,362 $ 5,362 $ 3,825 $ 3,825
Financial Liabilities
Deposits $ 384,483 $386,178 $ 293,877 $295,574
Federal Funds Purchased and Securities Sold
Under Agreements to Repurchase $ 11,722 $ 11,722 $ 21,528 $ 21,528
Other Borrowings $ 6,168 $ 6,168 $ 4,610 $ 4,610
The following methods and assumptions were used by the Company in estimating
fair value of each class of financial instruments for which it is practicable to
estimate that value:
- - Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents
approximate fair value.
- - Interest-Bearing Deposits in Banks - The carrying amounts of interest-bearing
deposits in Banks approximate fair value.
- - Securities - Fair values for securities are based on quoted market prices.
- - Loans - For variable-rate loans that reprice frequently and have no
significant change in credit risk, fair values are based on carrying values.
Fair values for certain mortgage loans and other consumer loans is estimated
using the quoted market prices for securities backed by similar loans, adjusted
for differences in loan characteristics. The fair value of other types of loans
is estimated by discounting the future cash flows using the current rates at
which similar loans would be made to borrowers of similar credit ratings
quality. Fair values for impaired loans are estimated using discounted cash flow
analysis or underlying collateral values, where applicable.
- - Deposit Liabilities - The fair value of demand deposits, savings accounts and
certain money market deposits is the amount payable on demand at the reporting
date. The fair value for fixed-rate certificates of deposit is 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.
F - 30
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - FAIR VALUE OF FINANCIAL INSTRUMENTS - continued
- - Federal Funds Purchased and Securities Sold Under Agreements to Repurchase
- - These borrowings generally mature in 90 days or less and, accordingly, the
carrying amount reported in the balance sheet approximates fair value.
- - Other Borrowings - Other borrowings carrying amount reported in the
balance sheet approximates fair value.
NOTE 17 - OFF-BALANCE-SHEET ACTIVITY
The Banks are parties to credit related financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of their customers. These financial instruments include commitments to
extend credit. Such commitments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the consolidated
balance sheet.
The Banks' exposure to credit loss is represented by the contractual amount of
these commitments. The Banks follow the same credit policies in making
commitments as they do for on-balance-sheet instruments.
The Banks' maximum exposure to credit risk for unfunded loan commitments and
standby letters of credit at December 31, 2002, was as follows:
December 31, December 31,
2002 2001
(in thousands)
Commitments to Extend Credit $70,613 $60,176
Standby Letters of Credit $ 2,375 $ 1,948
Commitments to extend credit are agreements to lend to customers. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of fees. 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 Banks evaluate each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Banks on extension of credit, is based on management's credit
evaluation. Collateral held varies but may include accounts receivable,
inventory, property and equipment and income-producing commercial properties.
NOTE 18 - CONCENTRATIONS OF CREDIT RISK
Concentrations of credit risk or types of collateral arising from financial
instruments exist in relation to certain groups of customers. A group
concentration arises when a number of borrowers have similar economic
characteristics that would cause their ability to meet contractual obligations
to be similarly affected by changes in economic or other conditions. The Banks
had approximately $17 million and $14 million in loans related to the carpet
industry as of December 31, 2002 and 2001, respectively.
F - 31
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - SUPPLEMENTAL FINANCIAL DATA
Components of other noninterest income or other noninterest expense in excess of
1% of the aggregate of total interest income and other income are as follows:
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
Noninterest Income -
Fees Related to Mortgage Loans Sold $ 1,316 $ 979 $ -
Noninterest Expense -
Professional Fees $ 946 $ 418 $ 491
Goodwill Amortization $ - $ 481 $ 443
Depreciation $ 586 $ 471 $ 274
Computer Fees $ 759 $ 587 $ 318
Printing and Supplies $ 377 $ 296 $ 175
Advertising $ 308 $ 265 $ 156
Telephone $ 325 $ - $ 146
NOTE 20 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Financial information pertaining only to First Security Group, Inc. is as
follows:
CONDENSED BALANCE SHEET
December 31, December 31,
2002 2001
(in thousands)
ASSETS
Cash and Due from Bank Subsidiaries $ 11,448 $ 1,894
Investment in Common Stock of Subsidiaries 56,233 37,001
Premises and Equipment, net - 2
Other Assets 373 368
------------- -------------
TOTAL ASSETS $ 68,054 $ 39,265
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES $ 121 $ -
STOCKHOLDERS' EQUITY 67,933 39,265
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 68,054 $ 39,265
============= =============
F - 32
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY - continued
CONDENSED STATEMENT OF OPERATIONS
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
INCOME
Management Fees $ 1,441 $ 848 $ 791
Interest 18 - 25
Miscellaneous - - 4
-------------- -------------- --------------
Total Income 1,459 848 820
-------------- -------------- --------------
EXPENSES
Interest - 67 -
Salaries and Employee Benefits 1,382 696 570
Other 747 372 329
-------------- -------------- --------------
Total Expenses 2,129 1,135 899
-------------- -------------- --------------
LOSS BEFORE INCOME TAXES AND EQUITY
IN UNDISTRIBUTED NET INCOME (LOSS)
OF SUBSIDIARIES (670) (287) (79)
Income Tax Benefit (257) (66) (30)
-------------- -------------- --------------
LOSS BEFORE EQUITY IN UNDISTRIBUTED
NET INCOME (LOSS) OF SUBSIDIARIES (413) (221) (49)
Equity in Undistributed Net Income (Loss) of
Subsidiaries 3,015 239 (517)
-------------- -------------- --------------
NET INCOME (LOSS) $ 2,602 $ 18 $ (566)
============== ============== ==============
F - 33
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY - continued
CONDENSED STATEMENT OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2002 2001 2000
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss) $ 2,602 $ 18 $ (566)
Adjustments to Reconcile Net Income (Loss)
to Net Cash Used by Operating Activities -
Equity in Undistributed Net Income (Loss) of
Subsidiaries (3,015) (239) 517
Common Stock Issued in Lieu of Subordinated Debt
Interest - 67 -
Depreciation - - 19
Increase in Other Assets (5) (25) (26)
(Decrease) Increase in Liabilities 121 (1) (74)
-------------- -------------- --------------
NET CASH USED BY OPERATING ACTIVITIES (297) (180) (130)
-------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net Decrease in Interest-Bearing Deposits
in Dalton Whitfield Bank - - 9,604
(Additions to) Disposal of Premises and Equipment 2 (2) (1,096)
Investments in/Acquisition of Subsidiaries (15,846) (6,396) (14,547)
-------------- -------------- --------------
NET CASH USED BY INVESTING ACTIVITIES (15,844) (6,398) (6,039)
-------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Issuance of Subordinated Debt - 2,250 -
Proceeds from Issuance of Common Stock Less
Stock Issuance Costs of $71 in 2002 and $446 in 2001 25,695 6,200 -
-------------- -------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 25,695 8,450 -
-------------- -------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 9,554 1,872 (6,169)
CASH AND CASH EQUIVALENTS - beginning
of period 1,894 22 6,191
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS - end of period $ 11,448 $ 1,894 $ 22
============== ============== ==============
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES
Unrealized Appreciation of Securities, net of tax $ 371 $ 136 $ 144
Conversion of Subordinated Debt to Common Stock $ - $ 2,250 $ -
F - 34
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - QUARTERLY SUMMARIZED FINANCIAL INFORMATION (UNAUDITED)
First Quarter Second Quarter Third Quarter Fourth Quarter
2002 2002 2002 2002
----------------------------------------------------------------
(in thousands, except per share data)
Interest Income $ 5,787 $ 6,024 $ 6,753 $ 7,057
Interest Expense 2,052 1,970 2,184 2,211
-------------- --------------- -------------- ---------------
Net Interest Income 3,735 4,054 4,569 4,846
Provision for Loan Losses 110 139 561 1,138
-------------- --------------- -------------- ---------------
Net Interest Income After Provision
for Loan Losses 3,625 3,915 4,008 3,708
Noninterest Income 847 903 908 1,161
Noninterest Expense 3,169 3,565 3,832 4,349
-------------- --------------- -------------- ---------------
Income Before Income Tax Provision 1,303 1,253 1,084 520
Income Tax Provision 497 474 441 146
-------------- --------------- -------------- ---------------
Net Income $ 806 $ 779 $ 643 $ 374
============== =============== ============== ===============
Net Income Per Share *
Basic $ 0.16 $ 0.13 $ 0.09 $ 0.04
Diluted $ 0.16 $ 0.13 $ 0.08 $ 0.04
Shares Outstanding
Basic 5,010 5,975 7,549 7,579
Diluted 5,092 6,057 7,631 7,660
* The sum of the 2002 and 2001 quarterly earnings per share may differ from
the annual earnings per share because of the differences in the weighted average
number of common shares outstanding and common shares used in the quarterly and
annual computation as well as differences in rounding.
F - 35
FIRST SECURITY GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - QUARTERLY SUMMARIZED FINANCIAL INFORMATION (UNAUDITED) - continued
First Quarter Second Quarter Third Quarter Fourth Quarter
2001 2001 2001 2001
------------------------------------------------------------------
(in thousands, except per share data)
Interest Income $ 4,376 $ 4,973 $ 5,649 $ 5,795
Interest Expense 2,183 2,460 2,703 2,437
-------------- ---------------- --------------- ---------------
Net Interest Income 2,193 2,513 2,946 3,358
Provision for Loan Losses 278 703 843 672
-------------- ---------------- --------------- ---------------
Net Interest Income After Provision
for Loan Losses 1,915 1,810 2,103 2,686
Noninterest Income 499 570 676 998
Noninterest Expense 2,256 2,459 2,957 3,332
-------------- ---------------- --------------- ---------------
Income (Loss) Before Income Tax
Provision (Benefit) 158 (79) (178) 352
Income Tax Provision (Benefit) 65 (28) (63) 261
-------------- ---------------- --------------- ---------------
Net Income (Loss) $ 93 $ (51) $ (115) $ 91
============== ================ =============== ===============
Net Income (Loss) Per Share *
Basic and Diluted $ 0.02 $ (0.01) $ (0.03) $ 0.02
Shares Outstanding
Basic 4,106 4,108 4,289 4,900
Diluted 4,106 4,108 4,601 5,018
* The sum of the 2002 and 2001 quarterly earnings per share may differ from
the annual earnings per share because of the differences in the weighted average
number of common shares outstanding and common shares used in the quarterly and
annual computation as well as differences in rounding.
F - 36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting
and financial disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Information on the directors and officers of First Security is included in
First Security's Proxy Statement for the Annual Meeting of Shareholders to be
held on May 22, 2003 (the Proxy Statement) and is hereby incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information on First Security's executive compensation is included in the
Proxy Statement and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information on the number of shares of common stock beneficially owned by
(1) each current director of the First Security, (2) each executive officer
listed in the Summary Compensation Table, and (3) all current executive officers
and directors as a group is included in the Proxy Statement and is hereby
incorporated by reference. As of March 14, 2003, First Security did not have any
shareholders who beneficially owned more than 5% of the outstanding common
stock.
The following table sets forth information regarding the Company's equity
compensation plans under which shares of the Company's common stock are
authorized for issuance. The only equity compensation plans maintained by the
Company are the First Security Group, Inc. Second Amended and Restated 1999
Long-Term Incentive Plan and the First Security Group, Inc. 2002 Long-Term
Incentive Plan.
Number of shares
remaining available for
Number of securities to be Weighted-average exercise future issuance under the
issued upon exercise of price of Plans (excludes
outstanding options outstanding options outstanding options)
-------------------------- -------------------------- --------------------------
Equity compensation plans
approved by security
holders 496,645 $ 8.38 353,355
Equity compensation plans
not approved by security
holders -- -- --
Total 496,645 $ 8.38 353,355
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
included in the Proxy Statement and is hereby incorporated by reference.
ITEM 14. CONTROLS AND PROCEDURES
First Security's Chief Executive Officer and Chief Financial Officer
performed an evaluation within the last ninety days of the effectiveness of the
design and operation of First Security's disclosure controls and procedures.
Based on that evaluation, such officers concluded that First Security's
disclosure controls and procedures were effective as of December 31, 2002. There
have been no significant changes in First Security's internal controls or in
other factors that could significantly affect internal controls subsequent to
December 31, 2002
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits.
(1) List of All Financial Statements. The following consolidated financial
statements and report of independent certified public accountants of
the Company are included in this Annual Report on Form 10-K:
- Independent Auditor's Report.
- Consolidated Balance Sheets as of December 31, 2002 and 2001.
82
- Consolidated Statements of Operations for the Years Ended
December 31, 2002, 2001 and 2000.
- Consolidated Statements of Shareholders' Equity for the Years
ended December 31, 2002, 2001 and 2000.
- Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000.
- Notes to Consolidated Financial Statements.
(3) Exhibits Required by Item 601. The following exhibits are attached
hereto or incorporated by reference herein (numbered to correspond to
Item 601(a) of Regulation S-K, as promulgated by the Securities and
Exchange Commission):
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 Articles of Incorporation of the Company (Incorporated by reference
from Exhibit 3.1 to the Company's Registration Statement on Form S-1
dated April 20, 2001, File No. 333-59338 (the "Form S-1")).
3.2 Bylaws of the Company (Incorporated by reference from Exhibit 3.2 to
the Form S-1).
10.1 The Company's Second Amended and Restated 1999 Long-Term Incentive
Plan (Incorporated by reference from Exhibit 10.1 to the Form S-1).
10.2 The Company's 2002 Long-Term Incentive Plan. (Incorporated by
reference from Appendix A to the Company's Proxy Statement filed
August 16, 2002).
21.1 Subsidiaries of the Registrant.
23.1 Consent of Joseph Decosimo and Company, LLP
(b) Reports on Form 8-K. The following reports on Form 8-K were filed
during the last quarter of the period covered by this Form 10-K.
Current Report on Form 8-K dated November 4, 2002 and filed November
4, 2002, Items 5 and 7.
Current Report on Form 8-K dated November 27, 2002 and filed November
27, 2002, Item 5, 7 and 9.
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350.
83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1954, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
FIRST SECURITY GROUP, INC.
BY: /s/ Rodger B. Holley
----------------------------------------
Rodger B. Holley
President and Chief Executive Officer
DATE: March 31, 2003
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the report has been signed by the following persons on behalf of the registrant
and in the capacities indicated and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Rodger B. Holley President, Chief Executive Officer and March 31, 2003
- -------------------------------
Rodger B. Holley Chairman of the Board of Directors
(Principal Executive Officer)
/s/ William L. Lusk, Jr. Secretary, Chief Financial Officer, and March 31, 2003
- -------------------------------
William L. Lusk, Jr. Executive Vice-President
(Principal Financial and
Accounting Officer)
/s/ Larry R. Belk Director March 31, 2003
- -------------------------------
Larry R. Belk
/s/ Clayton Causby Director March 31, 2003
- -------------------------------
Clayton Causby
/s/ Kenneth C. Dyer, III Director March 31, 2003
- -------------------------------
Kenneth C. Dyer
/s/ Douglas F. Heuer, III Director March 31, 2003
- -------------------------------
Douglas F. Heuer, III
/s/ Carol H. Jackson Director March 31, 2003
- -------------------------------
Carol H. Jackson
/s/ Ralph L. Kendall Director March 31, 2003
- -------------------------------
Ralph L. Kendall
/s/ William B. Kilbride Director March 31, 2003
- -------------------------------
William B. Kilbride
/s/ D. Ray Marler Director March 31, 2003
- -------------------------------
D. Ray Marler
84
/s/ Lloyd L. Montgomery, III Director March 31, 2003
- -------------------------------
Lloyd L. Montgomery, III
/s/ Hugh J. Moser, III Director March 31, 2003
- -------------------------------
Hugh J. Moser, III
/s/ H. Patrick Wood Director March 31, 2003
- -------------------------------
H. Patrick Wood
85
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Rodger B. Holley, Chief Executive Officer of First Security Group, Inc.,
certify that:
1. I have reviewed this annual report on Form 10-K of First Security Group,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer(s) and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 31, 2003
/s/ Rodger B. Holley
---------------------------------
Rodger B. Holley
Chief Executive Officer
86
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, William L. Lusk, Jr., Chief Financial Officer of First Security Group, Inc.,
certify that:
1. I have reviewed this annual report on Form 10-K of First Security Group,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer(s) and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 31, 2003
/s/ William L. Lusk, Jr.
---------------------------------------
William L. Lusk, Jr.
Chief Financial Officer
87