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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2002
 
Commission File Number: 001-15089
 
Fidelity BancShares (N.C.), Inc.
(Exact name of Registrant as specified in its charter)
 
Delaware
  
56-1586543
(State or other jurisdiction of
  
(I.R.S. Employer
incorporation or organization)
  
Identification Number)
 
100 South Main Street, Fuquay-Varina, North Carolina 27526
(Address of principal executive offices) (Zip code)
 
(919) 552-2242
(Registrant’s telephone number, including area code)
 
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve 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 one hundred eighty-one days.
 
Yes  x    No  ¨
 
Common Stock, $25 Par Value—28,011 shares
(Number of shares outstanding, by class, as of August 13, 2002)
 

 
PART I.    FINANCIAL INFORMATION
 
ITEM 1.    FINANCIAL STATEMENTS
 
FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
 
    
June 30, 2002
     
December 31, 2001
     
June 30, 2001
  
    
(unaudited)
            
(unaudited)
  
ASSETS
                           
Cash and due from banks
   
$
38,693,697
 
   
$
46,517,398
 
   
$
39,909,797
 
Interest bearing deposits in other banks
   
 
24,376,494
 
   
 
28,462,716
 
   
 
57,444,366
 
Overnight funds sold
   
 
34,800,000
 
   
 
51,200,000
 
   
 
60,800,000
 
    
  
  
Total cash and cash equivalents
   
 
97,870,191
 
   
 
126,180,114
 
   
 
158,154,163
 
    
  
  
Investment securities:
                           
Held to maturity (estimated fair value of $118,545,700, $126,502,713, and $110,887,388, respectively)
   
 
118,067,930
 
   
 
125,446,167
 
   
 
109,975,854
 
Available for sale (cost of $3,566,009, $3,633,777 and $3,644,668, respectively)
   
 
12,917,315
 
   
 
11,595,935
 
   
 
12,694,789
 
    
  
  
Total investment securities
   
 
130,985,245
 
   
 
137,042,102
 
   
 
122,670,643
 
    
  
  
Loans
   
 
707,360,831
 
   
 
668,984,155
 
   
 
631,041,705
 
Allowance for loan losses
   
 
(10,437,661
)
   
 
(9,312,384
)
   
 
(8,606,851
)
    
  
  
Loans, net
   
 
696,923,170
 
   
 
659,671,771
 
   
 
622,434,854
 
    
  
  
Federal Home Loan Bank of Atlanta stock, at cost
   
 
2,467,600
 
   
 
2,309,400
 
   
 
2,309,400
 
Premises and equipment, net
   
 
34,845,734
 
   
 
35,575,442
 
   
 
34,685,348
 
Accrued interest receivable
   
 
4,218,272
 
   
 
5,453,035
 
   
 
4,735,676
 
Intangible assets
   
 
16,588,454
 
   
 
17,311,024
 
   
 
18,072,079
 
Other assets
   
 
1,480,081
 
   
 
1,176,004
 
   
 
1,787,669
 
    
  
  
Total assets
   
$
985,378,747
 
   
$
984,718,892
 
   
$
964,849,832
 
    
  
  
LIABILITIES AND SHAREHOLDERS’ EQUITY
                           
Deposits:
                           
Noninterest-bearing demand deposits
   
$
151,406,417
 
   
$
140,965,066
 
   
$
130,108,033
 
Savings and interest-bearing demand deposits
   
 
298,994,546
 
   
 
294,219,134
 
   
 
278,266,199
 
Time deposits
   
 
391,497,761
 
   
 
406,251,104
 
   
 
411,509,026
 
    
  
  
Total deposits
   
 
841,898,724
 
   
 
841,435,304
 
   
 
819,883,258
 
Short-term borrowings
   
 
24,528,546
 
   
 
27,072,692
 
   
 
28,633,244
 
Long-term borrowings
   
 
23,000,000
 
   
 
23,000,000
 
   
 
23,000,000
 
Accrued interest payable
   
 
4,573,892
 
   
 
6,257,923
 
   
 
7,652,632
 
Other liabilities
   
 
2,533,722
 
   
 
1,922,588
 
   
 
3,226,664
 
    
  
  
Total liabilities
   
 
896,534,884
 
   
 
899,688,507
 
   
 
882,395,798
 
    
  
  
Shareholders’ equity:
                           
Common stock ($25 par value; 29,200 shares authorized; 28,011, 28,026, and 28,070 shares issued and outstanding, respectively)
   
 
700,275
 
   
 
700,650
 
   
 
701,750
 
Surplus
   
 
6,163,380
 
   
 
6,166,681
 
   
 
6,176,362
 
Accumulated other comprehensive income
   
 
5,657,540
 
   
 
4,817,106
 
   
 
5,475,323
 
Retained earnings
   
 
76,322,668
 
   
 
73,345,948
 
   
 
70,100,599
 
    
  
  
Total shareholders’ equity
   
 
88,843,863
 
   
 
85,030,385
 
   
 
82,454,034
 
    
  
  
Total liabilities and shareholders’ equity
   
$
985,378,747
 
   
$
984,718,892
 
   
$
964,849,832
 
    
  
  
 
See accompanying notes to consolidated financial statements.

2

 
FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME
 
    
Three months ended June 30,
   
Six months ended June 30,
    
2002
     
2001
   
2002
     
2001
    
(unaudited)
   
(unaudited)
Interest income:
                                
Interest and fees on loans
   
$
12,726,068
 
   
$
14,199,407
   
$
25,228,984
 
   
$
28,887,796
Interest and dividends on investment securities:
                                
Taxable interest income
   
 
1,047,637
 
   
 
1,983,952
   
 
2,395,036
 
   
 
4,430,445
Dividend income
   
 
69,236
 
   
 
74,267
   
 
135,594
 
   
 
150,046
Interest on federal funds sold
   
 
119,406
 
   
 
699,375
   
 
305,483
 
   
 
971,944
    
  
  
  
Total interest income
   
 
13,962,347
 
   
 
16,957,001
   
 
28,065,097
 
   
 
34,440,231
    
  
  
  
Interest expense:
                                
Deposits
   
 
4,220,215
 
   
 
7,139,879
   
 
8,829,725
 
   
 
14,631,439
Short-term borrowings
   
 
61,695
 
   
 
219,501
   
 
127,272
 
   
 
464,967
Long-term borrowings
   
 
488,750
 
   
 
488,750
   
 
977,500
 
   
 
977,500
    
  
  
  
Total interest expense
   
 
4,770,660
 
   
 
7,848,130
   
 
9,934,497
 
   
 
16,073,906
    
  
  
  
Net interest income
   
 
9,191,687
 
   
 
9,108,871
   
 
18,130,600
 
   
 
18,366,325
Provision for loan losses
   
 
700,000
 
   
 
750,000
   
 
1,450,000
 
   
 
1,500,000
    
  
  
  
Net interest income after provision for loan losses
   
 
8,491,687
 
   
 
8,358,871
   
 
16,680,600
 
   
 
16,866,325
    
  
  
  
Noninterest income:
                                
Service charges on deposit accounts
   
 
1,637,208
 
   
 
1,562,994
   
 
3,202,345
 
   
 
2,805,064
Other service charges and fees
   
 
946,352
 
   
 
813,873
   
 
1,797,802
 
   
 
1,554,130
Other income
   
 
50,607
 
   
 
25,409
   
 
92,820
 
   
 
47,595
Gain on exchange of marketable equity securities
   
 
—  
 
   
 
—  
   
 
—  
 
   
 
458,395
Gain (loss) on sale of marketable equity securities
   
 
(71,068
)
   
 
43,083
   
 
(71,068
)
   
 
43,083
    
  
  
  
Total noninterest income
   
 
2,563,099
 
   
 
2,445,359
   
 
5,021,899
 
   
 
4,908,267
    
  
  
  
Noninterest expense:
                                
Salaries and employee benefits
   
 
4,575,916
 
   
 
4,244,581
   
 
9,089,798
 
   
 
8,428,941
Occupancy and equipment
   
 
1,212,521
 
   
 
1,195,216
   
 
2,441,087
 
   
 
2,396,101
Data processing
   
 
809,441
 
   
 
789,888
   
 
1,594,424
 
   
 
1,500,917
Amortization of intangibles
   
 
361,285
 
   
 
380,528
   
 
722,570
 
   
 
727,636
Other expense
   
 
1,158,124
 
   
 
1,303,529
   
 
2,334,018
 
   
 
2,564,812
Impairment loss on fixed assets
   
 
143,224
 
   
 
173,317
   
 
143,224
 
   
 
477,972
    
  
  
  
Total noninterest expense
   
 
8,260,511
 
   
 
8,087,059
   
 
16,325,121
 
   
 
16,096,380
    
  
  
  
Net income before income taxes
   
 
2,794,275
 
   
 
2,717,171
   
 
5,377,378
 
   
 
5,678,212
Income tax expense
   
 
995,392
 
   
 
993,013
   
 
1,918,538
 
   
 
2,074,518
    
  
  
  
Net income
   
$
1,798,883
 
   
$
1,724,158
   
$
3,458,840
 
   
$
3,603,694
    
  
  
  
Per share information:
                                
Net income
   
$
64.22
 
   
$
61.42
   
$
123.46
 
   
$
128.38
Cash dividends declared
   
$
8.00
 
   
$
8.00
   
$
16.00
 
   
$
16.00
Weighted average shares outstanding
   
 
28,011
 
   
 
28,070
   
 
28,017
 
   
 
28,070
 
See accompanying notes to consolidated financial statements.

3

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited)
 
    
Common Stock
     
Surplus
     
Accumulated other Comprehensive income
   
Retained earnings
     
Comprehensive income
   
Total shareholders’ equity
  
    
Shares
     
Amount
                 
Balance December 31, 2000
   
28,070
 
   
$
701,750
 
   
$
6,176,362
 
   
$
3,688,615
   
$
66,946,042
 
          
$
77,512,769
 
    
  
  
  
  
         
Net income
   
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
   
 
3,603,694
 
   
$
3,603,694
   
 
3,603,694
 
Cash dividends ($16.00 per share)
   
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
   
 
(449,137
)
          
 
(449,137
)
Unrealized gain on securities available for sale, net of deferred taxes of $1,108,933
   
—  
 
   
 
—  
 
   
 
—  
 
   
 
1,786,708
   
 
—  
 
   
 
1,786,708
   
 
1,786,708
 
    
  
  
  
  
  
  
Comprehensive income
                                            
$
5,390,402
         
                                             
        
Balance June 30, 2001
   
28,070
 
   
$
701,750
 
   
$
6,176,362
 
   
$
5,475,323
   
$
70,100,599
 
          
$
82,454,034
 
    
  
  
  
  
         
Balance December 31, 2001
   
28,026
 
   
$
700,650
 
   
$
6,166,681
 
   
$
4,817,106
   
$
73,345,948
 
          
$
85,030,385
 
    
  
  
  
  
         
Net income
   
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
   
 
3,458,840
 
   
$
3,458,840
   
 
3,458,840
 
Cash dividends ($16.00 per share)
   
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
   
 
(448,296
)
          
 
(448,296
)
Purchase and retirement of common stock
   
(15
)
   
 
(375
)
   
 
(3,301
)
   
 
—  
   
 
(33,824
)
          
 
(37,500
)
Unrealized gain on securities available for sale, net of deferred taxes of $548,714
   
—  
 
   
 
—  
 
   
 
—  
 
   
 
840,434
   
 
—  
 
   
 
840,434
   
 
840,434
 
    
  
  
  
  
  
  
Comprehensive income
                                            
$
4,299,274
         
                                             
        
Balance June 30, 2002
   
28,011
 
   
$
700,275
 
   
$
6,163,380
 
   
$
5,657,540
   
$
76,322,668
 
          
$
88,843,863
 
    
  
  
  
  
         
 
See accompanying notes to consolidated financial statements.

4

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
    
Six months ended June 30,
  
    
2002
     
2001
  
Cash flows from operating activities:
                  
Net income
   
$
3,458,840
 
   
$
3,603,694
 
Adjustments to reconcile net income to net cash provided by operating activities:
                  
Depreciation and amortization
   
 
1,967,935
 
   
 
1,934,004
 
Amortization (accretion) on investment securities
   
 
68,436
 
   
 
(301,210
)
Gain on disposition of premises and equipment
   
 
(12,758
)
   
 
(9,542
)
Impairment loss on fixed assets
   
 
143,224
 
   
 
477,972
 
Provision for loan losses
   
 
1,450,000
 
   
 
1,500,000
 
Origination of loans held for sale
   
 
—  
 
   
 
(5,972,250
)
Proceeds from sales of loans held for sale
   
 
—  
 
   
 
6,004,882
 
Gain on sales of loans held for sale
   
 
—  
 
   
 
(32,632
)
Gain on exchange of marketable equity securities
   
 
—  
 
   
 
(458,395
)
Loss (gain) on sale of securities available for sale
   
 
71,068
 
   
 
(43,083
)
Proceeds from sales of other real estate owned
   
 
405,400
 
   
 
100,003
 
Gain on other real estate
   
 
(12,087
)
   
 
—  
 
Decrease in accrued interest receivable
   
 
1,234,763
 
   
 
1,226,091
 
Increase in other assets, net
   
 
(231,987
)
   
 
(369,861
)
Increase in other liabilities, net
   
 
62,419
 
   
 
427,765
 
(Decrease) increase in accrued interest payable
   
 
(1,684,031
)
   
 
1,346,451
 
    
  
Net cash provided by operating activities
   
 
6,921,222
 
   
 
9,433,889
 
    
  
Cash flows from investing activities:
                  
Purchase of securities held to maturity
   
 
(97,690,963
)
   
 
(89,770,124
)
Purchase of securities available for sale
   
 
(49,170
)
   
 
(1,000,066
)
Proceeds from maturities and issuer calls of securities held to maturity
   
 
105,000,762
 
   
 
123,000,272
 
Proceeds from sale of securities available for sale
   
 
45,870
 
   
 
501,478
 
Purchase of FHLB of Atlanta stock
   
 
(158,200
)
   
 
(139,700
)
Net increase in loans
   
 
(39,166,798
)
   
 
(12,954,009
)
Purchases of premises and equipment
   
 
(646,124
)
   
 
(718,071
)
Net cash received on branch purchases
   
 
—  
 
   
 
38,694,108
 
    
  
Net cash (used) provided by investing activities
   
 
(32,664,623
)
   
 
57,613,888
 
    
  
Cash flows from financing activities:
                  
Net increase (decrease) in deposits
   
 
463,420
 
   
 
(2,122,102
)
Net (decrease) increase in short-term borrowings
   
 
(2,544,146
)
   
 
1,991,658
 
Cash dividends paid
   
 
(448,296
)
   
 
(449,137
)
Purchase and retirement of common stock
   
 
(37,500
)
   
 
—  
 
    
  
Net cash used by financing activities
   
 
(2,566,522
)
   
 
(579,581
)
    
  
Net (decrease) increase in cash and cash equivalents
   
 
(28,309,923
)
   
 
66,468,196
 
Cash and cash equivalents at beginning of period
   
 
126,180,114
 
   
 
91,685,967
 
    
  
Cash and cash equivalents at end of period
   
$
97,870,191
 
   
$
158,154,163
 
    
  
Supplemental disclosures of cash flow information:
                  
Cash paid during the period for interest
   
$
11,618,528
 
   
$
14,727,455
 
    
  
Cash paid during the period for income taxes
   
$
2,352,995
 
   
$
2,367,160
 
    
  
Supplemental disclosure of noncash financing and investing activities:
                  
Unrealized gains on available-for-sale securities, net of deferred taxes of $548,714 and $1,108,933, respectively
   
$
840,434
 
   
$
1,786,708
 
    
  
Foreclosed loans transferred to other real estate
   
$
465,400
 
   
$
415,000
 
    
  
 
See accompanying notes to consolidated financial statements.

5

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1.    Basis of Presentation
 
Fidelity BancShares (N.C.), Inc. (“BancShares”) is the holding company for The Fidelity Bank (the “Bank”), which operates 64 branches primarily in central North Carolina, and FIDBANK Capital Trust I (the “Trust”), a statutory business trust created under the laws of the State of Delaware that issued $23.0 million of 8.50% Capital Securities (the “Capital Securities”) in June 1999 maturing in 2029. The Bank also has two wholly owned subsidiaries, Fidelity Properties, Inc. and TFB Financial Services.
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements.
 
In the opinion of management, the consolidated financial statements contain all material adjustments necessary to present fairly the consolidated financial position of BancShares as of and for each of the periods presented, and all such adjustments are of a normal recurring nature. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent 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.
 
These financial statements should be read in conjunction with financial statements and notes included in Fidelity BancShares (N.C.), Inc.’s Form 10K filed with the Securities and Exchange Commission. Certain amounts for prior periods have been reclassified to conform with statement presentations for 2002. However, the reclassifications have no effect on shareholders’ equity or net income as previously reported.
 
Note 2.    Adoption of New Accounting Standards
 
On July 20, 2001, The Financial Accounting Standards Board (FASB) issued Statement No. 141, “Business Combinations;” and Statement No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria which must be met for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that identifiable intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.”
 
BancShares was required to adopt the provisions of SFAS No. 141 as of June 30, 2001 and was required to adopt SFAS No. 142 effective January 1, 2002. Any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate accounting literature issued prior to SFAS No. 142. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 were amortized in 2001 prior to the adoption of SFAS No. 142 on January 1, 2002.
 
As of January 1, 2002, BancShares had intangible assets totaling $17,311,000. Management evaluated the BancShares existing intangible assets and goodwill as of January 1, 2002 and made appropriate reclassifications to conform to the new criteria in Statement 141 for recognition apart from goodwill, as further described below.
 
BancShares determined that upon adoption of Statement 142 on January 1, 2002, BancShares had $744,000 of goodwill that was no longer amortized beginning on January 1, 2002. The amortization expense associated with this goodwill during the six months ended June 30, 2001 was $38,000. In accordance with Statement 142, BancShares performed a transitional impairment test of this goodwill in the first six months of 2002 and deemed that no goodwill impairment existed. BancShares will continue to perform an annual impairment test of the goodwill hereafter.

6

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
The remaining intangible assets, totaling $16,567,000 at January 1, 2002, relate to acquisitions of branches that are being accounted for in accordance with Statement of Financial Accounting Standards No. 72 (Statement 72), “Accounting for Certain Acquisitions of Banking and Thrift Institutions.” Statement 72, which was not amended by Statement 142, requires that identified intangible assets and unidentified intangible assets associated with certain acquisitions of branches be amortized into expense. Accordingly, these intangible assets will continue to be amortized over their useful lives. Management has reviewed the useful lives of these assets, and will continue to do so in future periods, adjusting them downward where appropriate. The amortization expense associated with these branches was $723,000 and $689,000 for the six months ended June 30, 2002 and 2001, respectively.
 
The following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets as of June 30, 2002 and December 31, 2001 and the carrying amount of unamortized intangible assets as of June 30, 2002 and December 31, 2001.
 
      
June 30, 2002
     
December 31, 2001
      
Gross Carrying Amount
   
Accumulated Amortization
     
Gross Carrying Amount
   
Accumulated Amortization
      
(Dollars in thousands)
Amortized intangible assets:
                                
Branch acquisitions
     
$
22,094
   
$
6,250
     
$
22,094
   
$
5,527
      
  
    
  
Unamortized intangible assets:
                                
Goodwill
     
$
744
   
 
—  
     
$
744
   
 
—  
      
  
    
  
 
There was no change in the carrying amount of goodwill at June 30, 2002 compared to December 31, 2001.
 
The estimated amortization expense for intangible assets for the years ended December 31, 2002, 2003, 2004, 2005, 2006 and thereafter is as follows:
 
      
Estimated Amortization Expense
      
(Dollars in thousands)
2002
     
$
1,445
2003
     
 
1,445
2004
     
 
1,445
2005
     
 
1,445
2006
     
 
1,445
2007 and after
     
 
9,342
      
Total
     
$
16,567
      

7

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
The following table presents the adjusted effect on net income and on basic net income per share excluding the amortization of goodwill for the six months ended June 30, 2002 and 2001 and for the years ended December 31, 2001, 2000 and 1999:
 
    
For the six months
ended June 30,
    
2002
   
2001
    
(Dollars in thousands, except per share data)
Net income
   
$
3,459
   
$
3,604
Add back: Goodwill amortization
   
$
—  
   
$
38
    
  
Adjusted net income
   
$
3,459
   
$
3,642
    
  
Net income per share:
              
As reported
   
$
123.46
   
$
128.38
Goodwill amortization
   
$
—  
   
$
1.35
    
  
Adjusted net income per share
   
$
123.46
   
$
129.73
    
  
 
    
For the years ended December 31
    
2001
   
2000
   
1999
    
(Dollars in thousands,
except per share data)
Net income
   
$
7,397
   
$
8,101
   
$
7,637
Add back: Goodwill amortization
   
$
77
   
$
77
   
$
77
    
  
  
Adjusted net income
   
$
7,474
   
$
8,178
   
$
7,714
    
  
  
Net income per share:
                     
As reported
   
$
263.71
   
$
287.97
   
$
270.05
Goodwill amortization
   
$
2.75
   
$
2.74
   
$
2.72
    
  
  
Adjusted net income per share
   
$
266.46
   
$
290.71
   
$
272.77
    
  
  
 
Note 3.    Net Income Per Share
 
Net income per share has been computed by dividing net income by the weighted average number of shares outstanding during the period. For all periods presented, BancShares had no potential dilutive common stock.
 
Note 4.    Allowance for Loan Losses
 
A summary of the allowance for loan losses follows:
 
    
Six months ended June 30,
  
    
2002
     
2001
  
    
(Unaudited)
  
Balance at beginning of year
   
$
9,312,384
 
   
$
7,297,833
 
Provision for loan losses
   
 
1,450,000
 
   
 
1,500,000
 
Loans charged off
   
 
(1,322,101
)
   
 
(787,112
)
Loan recoveries
   
 
997,378
 
   
 
596,130
 
    
  
Balance at end of the period
   
$
10,437,661
 
   
$
8,606,851
 
    
  

8

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
Note 5.    Long Term Borrowings
 
The $23.0 million long-term obligations at June 30, 2002 are Capital Trust Securities of the Trust. These long-term obligations, which qualify as Tier 1 Capital for BancShares, bear interest at 8.50% and mature in 2029. BancShares may redeem the long-term obligations in whole or in part on or after June 30, 2004. The sole asset of the Trust is $23.7 million of 8.50% Junior Subordinated Debentures of BancShares due 2029. BancShares has entered into a guaranty agreement which, when taken together with its obligations under the trust agreement under which the Trust exists, the junior subordinated debentures, and the indenture under which the debentures were issued, provides a full and unconditional guarantee on a subordinated basis by BancShares of the Trust’s payment of distributions and other payments on the capital securities.
 
Note 6.    Branch Acquisitions
 
In February 2001, BancShares acquired the Mebane, Rockingham and Yanceyville, North Carolina branches of First Union National Bank. This acquisition was accounted for as a purchase, and, therefore the results of operations prior to purchase of the branches are not included in the consolidated financial statements. The combined loans and deposits acquired were $3.9 million and $49.5 million, respectively, and the purchase included $6.0 million in Statement 72 intangible assets.
 
Note 7.    Gain on Marketable Equity Securities
 
During the second quarter of 2002, BancShares recognized a securities loss of $71,068. This loss was the result of selling some available for sale equity securities. There were no securities gains or losses recognized in the first quarter of 2002. During the first quarter of 2001, BancShares recognized a securities gain of $458,395. This gain was recognized as a result of a business combination involving a company in which BancShares had an equity interest. During the second quarter of 2001, BancShares recognized a securities gain of $43,083 when the equity interest received in the business combination was sold.
 
Note 8.    Impairment Loss on Fixed Assets
 
In April 2001, BancShares analyzed the results of operations for two branches through the first three months taking into consideration recent economic conditions and the performance of these branches during the first quarter. BancShares concluded that the carrying value of these branches was impaired and therefore recorded an impairment loss of $304,656 to reduce the carrying value of these branches to fair value. The fixed assets consisted primarily of leasehold improvements, which are deemed to have very minimal fair value. This impairment charge was recognized in the first quarter and the branches were considered assets to be held and used. In late April 2001, BancShares approved the closing of the two branches in the second and third quarters of 2001. BancShares recorded an additional charge of $173,000 in the second quarter, which is primarily related to the remaining lease payments and costs to close these branches. During the third quarter of 2001 management revised its estimate of closing costs and recorded a recovery of $7,232.
 
In May 2002, BancShares approved the closing of one branch. BancShares analyzed the results of operations of the branch since its inception in 1999 and determined that the loss experience would not turn around in the near future. At June 30, 2002, BancShares had accrued disposition costs of $143,000 including $103,000 for losses on fixed assets, $20,000 for lease cancellation fees, and $20,000 for costs to close the branch.
 
Note 9.    Related Parties
 
BancShares has entered into various service contracts with another bank holding company (the “Corporation”) and its subsidiary. The Corporation has two significant shareholders, who also are significant shareholders of BancShares.
 
The first significant shareholder at June 30, 2002, beneficially owned 11,155 shares, or 39.82%, of BancShares’ outstanding common stock. At the same date, the second significant shareholder beneficially owned 1,696 shares, or 6.05%, of BancShares’ outstanding common stock.
 
These two significant shareholders are directors and executive officers of the Corporation and at June 30, 2002, beneficially owned 2,529,080 shares, or 28.75%, and 1,404,121 shares, or 15.96%, of the Corporation’s outstanding Class A common stock, and 650,678 shares, or 38.66%, and 199,052 shares, or 11.83%, of the Corporation’s outstanding Class B common stock. The above totals include 472,855 Class A common shares, or 5.38%, and 104,644 Class B Common shares, or 6.22%, that are considered to be beneficially owned by both of the shareholders and, therefore, are included in each of their totals.

9

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
The following table lists the various charges paid to the Corporation:
 
    
Six Months Ended
June 30,
    
2002
   
2001
    
(Unaudited)
    
(Dollars in thousands)
Data and item processing
   
$
1,612
   
$
1,542
Forms, supplies and equipment
   
 
143
   
 
159
Trustee for employee benefit plans
   
 
30
   
 
35
    
  
    
$
1,785
   
$
1,736
    
  
 
The Bank also has a correspondent relationship with the Corporation. Correspondent account balances with the Corporation included in cash and due from banks and overnight funds sold totaled $32,545,839 and $41,448,498 at June 30, 2002 and December 31, 2001, respectively.
 
BancShares is related through common ownership with Southern Bank and Trust Co. (“Southern”) in that the aforementioned two significant shareholders of BancShares and certain of their related parties are also significant shareholders of Southern. BancShares has contracted with Southern to service on its behalf $5.5 million of BancShares’ mortgage loans.

10

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
TABLE 1.
 
FINANCIAL SUMMARY
 
    
2002
     
2001
  
    
Second Quarter
     
First Quarter
     
Fourth Quarter
     
Third Quarter
     
Second Quarter
  
    
(Dollars in thousands, except per share data)
         
Summary of Operations
                                             
Interest income
   
$
13,962
 
   
$
14,103
 
   
$
15,341
 
   
$
16,375
 
   
$
16,957
 
Interest expense
   
 
4,770
 
   
 
5,164
 
   
 
6,175
 
   
 
7,265
 
   
 
7,848
 
    
  
  
  
  
Net interest income
   
 
9,192
 
   
 
8,939
 
   
 
9,166
 
   
 
9,110
 
   
 
9,109
 
Provision for loan losses
   
 
700
 
   
 
750
 
   
 
750
 
   
 
750
 
   
 
750
 
    
  
  
  
  
Net interest income after provision for loan losses
   
 
8,492
 
   
 
8,189
 
   
 
8,416
 
   
 
8,360
 
   
 
8,359
 
Noninterest income
   
 
2,563
 
   
 
2,459
 
   
 
2,531
 
   
 
2,511
 
   
 
2,445
 
Noninterest expense
   
 
8,261
 
   
 
8,065
 
   
 
8,027
 
   
 
7,794
 
   
 
8,087
 
    
  
  
  
  
Net income before income taxes
   
 
2,794
 
   
 
2,583
 
   
 
2,920
 
   
 
3,077
 
   
 
2,717
 
Income taxes
   
 
995
 
   
 
923
 
   
 
1,074
 
   
 
1,130
 
   
 
993
 
    
  
  
  
  
Net income
   
$
1,799
 
   
$
1,660
 
   
$
1,846
 
   
$
1,947
 
   
$
1,724
 
    
  
  
  
  
Selected Period-End Balances
                                             
Total assets
   
$
985,379
 
   
$
982,674
 
   
$
984,719
 
   
$
968,619
 
   
$
964,849
 
Investment securities and overnight funds sold
   
 
165,785
 
   
 
187,994
 
   
 
188,242
 
   
 
205,983
 
   
 
183,471
 
Loans, gross
   
 
707,361
 
   
 
685,901
 
   
 
668,984
 
   
 
647,894
 
   
 
631,042
 
Interest earning assets
   
 
899,990
 
   
 
898,203
 
   
 
887,998
 
   
 
879,437
 
   
 
874,266
 
Deposits
   
 
841,899
 
   
 
837,960
 
   
 
841,435
 
   
 
825,444
 
   
 
819,883
 
Interest bearing liabilities
   
 
738,021
 
   
 
747,142
 
   
 
750,543
 
   
 
743,060
 
   
 
741,408
 
Shareholders’ equity
   
 
88,844
 
   
 
86,722
 
   
 
85,030
 
   
 
82,519
 
   
 
82,454
 
Common shares outstanding
   
 
28,011
 
   
 
28,011
 
   
 
28,026
 
   
 
28,026
 
   
 
28,070
 
    
  
  
  
  
Selected Average Balances
                                             
Total assets
   
$
974,639
 
   
$
973,966
 
   
$
972,894
 
   
$
957,883
 
   
$
953,347
 
Investment securities and overnight funds sold
   
 
168,825
 
   
 
184,895
 
   
 
192,836
 
   
 
202,344
 
   
 
189,354
 
Loans, gross
   
 
696,944
 
   
 
677,628
 
   
 
659,783
 
   
 
640,277
 
   
 
628,356
 
Interest earning assets
   
 
893,310
 
   
 
889,398
 
   
 
887,880
 
   
 
874,718
 
   
 
868,094
 
Deposits
   
 
833,664
 
   
 
832,021
 
   
 
830,242
 
   
 
813,840
 
   
 
812,867
 
Interest bearing liabilities
   
 
738,015
 
   
 
743,769
 
   
 
743,768
 
   
 
735,973
 
   
 
736,776
 
Shareholders’ equity
   
 
88,377
 
   
 
86,530
 
   
 
84,509
 
   
 
83,627
 
   
 
81,522
 
Common shares outstanding
   
 
28,011
 
   
 
28,023
 
   
 
28,026
 
   
 
28,031
 
   
 
28,070
 
    
  
  
  
  
Profitability Ratios
                                             
Rate of return (annualized) on:
                                             
Total assets
   
 
0.74
%
   
 
0.69
%
   
 
0.75
%
   
 
0.81
%
   
 
0.73
%
Shareholders’ equity
   
 
8.16
%
   
 
7.78
%
   
 
8.67
%
   
 
9.24
%
   
 
8.48
%
Dividend payout ratio (1)
   
 
12.46
%
   
 
13.51
%
   
 
12.14
%
   
 
11.52
%
   
 
13.02
%
    
  
  
  
  
Liquidity and Capital Ratios (averages)
                                             
Loans to deposits
   
 
83.60
%
   
 
81.44
%
   
 
79.47
%
   
 
78.67
%
   
 
77.30
%
Shareholders’ equity to total assets
   
 
9.07
%
   
 
8.88
%
   
 
8.69
%
   
 
8.73
%
   
 
8.55
%
    
  
  
  
  
Per Share of Common Stock
                                             
Net income
   
$
64.22
 
   
$
59.24
 
   
$
65.88
 
   
$
69.45
 
   
$
61.42
 
Cash dividends
   
 
8.00
 
   
 
8.00
 
   
 
8.00
 
   
 
8.00
 
   
 
8.00
 
Book value (2)
   
 
3,171.75
 
   
 
3,096.01
 
   
 
3,033.98
 
   
 
2,944.37
 
   
 
2,937.44
 
    
  
  
  
  
(1)
 
For each indicated period, total common dividends declared divided by net income.
(2)
 
At the end of each indicated period, shareholders’ equity divided by the number of common shares outstanding.

11

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
TABLE 2.
Consolidated Taxable Equivalent Rate/Volume Variance Analysis—Year to date
 
    
2002
     
2001
     
Increase (decrease) due to:
  
    
Average
Balance
     
Interest
Income/
Expense
   
Yield/
Rate
     
Average
Balance
     
Interest
Income/
Expense
   
Yield/
Rate
     
Volume
     
Yield/
Rate
     
Total
Change
  
    
(Dollars in thousands)
  
ASSETS
                                                                         
Interest earning assets:
                                                                         
Loans (1) (2)
   
$
687,339
 
   
$
25,260
   
7.41
%
   
$
625,130
 
   
$
28,938
   
9.33
%
   
$
2,583
 
   
$
(6,261
)
   
$
(3,678
)
Taxable investment securities
   
 
128,380
 
   
 
2,193
   
3.44
 
   
 
129,896
 
   
 
3,555
   
5.52
 
   
 
(34
)
   
 
(1,328
)
   
 
(1,362
)
Overnight funds sold
   
 
36,231
 
   
 
305
   
1.70
 
   
 
42,892
 
   
 
972
   
4.57
 
   
 
(104
)
   
 
(563
)
   
 
(667
)
Other investments
   
 
14,603
 
   
 
136
   
1.88
 
   
 
12,723
 
   
 
150
   
2.38
 
   
 
16
 
   
 
(30
)
   
 
(14
)
Interest bearing deposits in other banks
   
 
24,812
 
   
 
203
   
1.65
 
   
 
36,927
 
   
 
875
   
4.78
 
   
 
(193
)
   
 
(479
)
   
 
(672
)
    
  
  
  
  
  
  
  
  
Total interest earning assets
   
$
891,365
 
   
$
28,097
   
6.36
%
   
$
847,568
 
   
$
34,490
   
8.21
%
   
$
2,268
 
   
$
(8,661
)
   
$
(6,393
)
    
  
  
  
  
  
  
  
  
Noninterest earning assets:
                                                                         
Cash and due from banks
   
 
34,715
 
                 
 
33,384
 
                                         
Premises and equipment
   
 
35,317
 
                 
 
34,834
 
                                         
Other assets
   
 
22,456
 
                 
 
24,992
 
                                         
Reserve for loan losses
   
 
(9,534
)
                 
 
(8,119
)
                                         
    
                
                                        
Total assets
   
$
974,319
 
                 
$
932,659
 
                                         
    
                
                                        
LIABILITIES & EQUITY
                                                                         
Interest bearing liabilities:
                                                                         
Demand deposits
   
$
107,874
 
   
$
171
   
0.32
%
   
$
106,473
 
   
$
530
   
1.00
%
   
$
(46
)
   
$
(313
)
   
$
(359
)
Savings deposits
   
 
190,838
 
   
 
1,490
   
1.57
 
   
 
167,428
 
   
 
2,405
   
2.90
 
   
 
279
 
   
 
(1,194
)
   
 
(915
)
Time deposits
   
 
395,841
 
   
 
7,169
   
3.65
 
   
 
401,376
 
   
 
11,696
   
5.88
 
   
 
(131
)
   
 
(4,396
)
   
 
(4,527
)
Short-term borrowings
   
 
23,323
 
   
 
127
   
1.10
 
   
 
25,038
 
   
 
465
   
3.75
 
   
 
(20
)
   
 
(318
)
   
 
(338
)
Long-term borrowings
   
 
23,000
 
   
 
978
   
8.57
 
   
 
23,000
 
   
 
978
   
8.57
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
    
  
  
  
  
  
  
  
  
Total interest bearing liabilities
   
$
740,876
 
   
$
9,935
   
2.70
%
   
$
723,315
 
   
$
16,074
   
4.48
%
   
$
82
 
   
$
(6,221
)
   
$
(6,139
)
    
  
  
  
  
  
  
  
  
Noninterest bearing liabilities:
                                                                         
Demand deposits
   
 
138,294
 
                 
 
118,906
 
                                         
Other liabilities
   
 
7,691
 
                 
 
10,011
 
                                         
Shareholders’ equity
   
 
87,458
 
                 
 
80,427
 
                                         
    
                
                                        
Total liabilities and equity
   
$
974,319
 
                 
$
932,659
 
                                         
    
                
                                        
Interest rate spread (3)
                   
3.66
%
                   
3.73
%
                           
                    
                  
                          
Net interest income and net interest margin (4)
            
$
18,162
   
4.11
%
            
$
18,416
   
4.38
%
   
$
2,186
 
   
$
(2,440
)
   
$
(254
)
             
                  
         
  
  
(1)
 
Average balances include non-accrual loans.
(2)
 
The average rate on nontaxable loans has been adjusted to a tax equivalent yield using a 39.485% tax rate for 2002 and 2001. The taxable equivalent adjustment was approximately $31,000 and $50,000 for the years 2002 and 2001, respectively.
(3)
 
Interest rate spread is the difference between earning asset yield and interest bearing liability rate.
(4)
 
Net interest margin is net interest income divided by average earning assets.

12

FIDELITY BANCSHARES (N.C.), INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
TABLE 3.
Consolidated Taxable Equivalent Rate/Volume Variance Analysis – Second Quarter
 
    
2002
     
2001
     
Increase (decrease) due to:
  
    
Average Balance
     
Interest Income/
Expense
   
Yield/
Rate
     
Average Balance
     
Interest Income/
Expense
   
Yield/
Rate
     
Volume
     
Yield/
Rate
     
Total Change
  
    
(Dollars in thousands)
  
ASSETS
                                                                         
Interest earning assets:
                                                                         
Loans (1) (2)
   
$
696,944
 
   
$
12,742
   
7.33
%
   
$
628,356
 
   
$
14,222
   
9.08
%
   
$
1,404
 
   
$
(2,884
)
   
$
(1,480
)
Taxable investment securities
   
 
127,946
 
   
 
945
   
2.96
 
   
 
112,616
 
   
 
1,470
   
5.24
 
   
 
157
 
   
 
(682
)
   
 
(525
)
Overnight funds sold
   
 
28,242
 
   
 
118
   
1.68
 
   
 
65,122
 
   
 
699
   
4.31
 
   
 
(275
)
   
 
(306
)
   
 
(581
)
Other investments
   
 
15,105
 
   
 
70
   
1.86
 
   
 
13,925
 
   
 
74
   
2.13
 
   
 
5
 
   
 
(9
)
   
 
(4
)
Interest bearing deposits in other banks
   
 
25,073
 
   
 
104
   
1.66
 
   
 
48,075
 
   
 
513
   
4.28
 
   
 
(170
)
   
 
(239
)
   
 
(409
)
    
  
  
  
  
  
  
  
  
Total interest earning assets
   
$
893,310
 
   
$
13,979
   
6.28
%
   
$
868,094
 
   
$
16,978
   
7.84
%
   
$
1,121
 
   
$
(4,120
)
   
$
(2,999
)
    
  
  
  
  
  
  
  
  
Noninterest earning assets:
                                                                         
Cash and due from banks
   
 
33,955
 
                 
 
34,079
 
                                         
Premises and equipment
   
 
35,119
 
                 
 
34,853
 
                                         
Other assets
   
 
22,030
 
                 
 
24,724
 
                                         
Reserve for loan losses
   
 
(9,775
)
                 
 
(8,403
)
                                         
    
                
                                        
Total assets
   
$
974,639
 
                 
$
953,347
 
                                         
    
                
                                        
LIABILITIES & EQUITY
                                                                         
Interest bearing liabilities:
                                                                         
Demand deposits
   
$
105,890
 
   
$
82
   
0.31
%
   
$
105,667
 
   
$
193
   
0.73
%
   
$
(13
)
   
$
(98
)
   
$
(111
)
Savings deposits
   
 
194,633
 
   
 
757
   
1.56
 
   
 
172,235
 
   
 
1,088
   
2.53
 
   
 
124
 
   
 
(455
)
   
 
(331
)
Time deposits
   
 
392,167
 
   
 
3,381
   
3.46
 
   
 
410,352
 
   
 
5,859
   
5.73
 
   
 
(208
)
   
 
(2,270
)
   
 
(2,478
)
Short-term borrowings
   
 
22,325
 
   
 
61
   
1.10
 
   
 
25,522
 
   
 
220
   
3.46
 
   
 
(18
)
   
 
(141
)
   
 
(159
)
Long-term borrowings
   
 
23,000
 
   
 
489
   
8.53
 
   
 
23,000
 
   
 
489
   
8.53
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
    
  
  
  
  
  
  
  
  
Total interest bearing liabilities
   
$
738,015
 
   
$
4,770
   
2.59
%
   
$
736,776
 
   
$
7,849
   
4.27
%
   
$
(115
)
   
$
(2,964
)
   
$
(3,079
)
    
  
  
  
  
  
  
  
  
Noninterest bearing liabilities:
                                                                         
Demand deposits
   
 
140,974
 
                 
 
124,613
 
                                         
Other liabilities
   
 
7,273
 
                 
 
10,436
 
                                         
Shareholders’ equity
   
 
88,377
 
                 
 
81,522
 
                                         
    
                
                                        
Total liabilities and equity
   
$
974,639
 
                 
$
953,347
 
                                         
    
                
                                        
Interest rate spread (3)
                   
3.69
%
                   
3.57
%
                           
                    
                  
                          
Net interest income and net interest margin (4)
            
$
9,209
   
4.14
%
            
$
9,129
   
4.22
%
   
$
1,236
 
   
$
(1,156
)
   
$
80
 
             
                  
         
  
  
(1)
 
Average balances include non-accrual loans.
(2)
 
The average rate on nontaxable loans has been adjusted to a tax equivalent yield using a 39.485% tax rate for 2002 and 2001. The taxable equivalent adjustment was approximately $15,000 and $23,000 for the years 2002 and 2001, respectively.
(3)
 
Interest rate spread is the difference between earning asset yield and interest bearing liability rate.
(4)
 
Net interest margin is net interest income divided by average earning assets.

13

 
ITEM 2.
   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Introduction
 
Management’s discussion and analysis of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of Fidelity BancShares (N.C.), Inc. and Subsidiaries (“BancShares”). This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and related notes presented within this report. The focus of this discussion concerns BancShares’ banking subsidiary, The Fidelity Bank (the “Bank”), which operates 64 branches in North Carolina.
 
Critical Accounting Policies
 
BancShares’ significant accounting policies are set forth in note 1 of the consolidated financial statements in the annual report on Form 10K. Of these significant accounting policies, BancShares considers its policy regarding the allowance for loan losses to be a critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. BancShares has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. BancShares’ assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers, which is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning BancShares’ allowance for loan losses and related matters, see Asset Quality and Provision for Loan Losses.
 
Financial Condition and Results of Operations.
 
Net Income.    In the first six months of 2002, BancShares’ net income decreased $145,000 to $3.5 million from $3.6 million in the second quarter of 2001, a decrease of 4.02%. Net income for the second quarter of 2002 increased $75,000 or 4.33% when compared to the same period of 2001. The increase in net income for the second quarter resulted primarily from the decline in interest rates, which resulted in an increase in net interest income, and an increase in noninterest income, which was partially offset by increased noninterest expense.
 
Net income per share for the first six months of 2002 was $123.46, a decrease of $4.92 per share, or 3.83%, from $128.38 per share in 2001. For the second quarter of 2002, net income per share was $64.22, an increase of $2.80 or 4.56%, from $61.42 per share for the second quarter of 2001. Return on average assets for the first six months of 2002 and 2001 was 0.72% and 0.78%, respectively. For the second quarter of 2002 and 2001, return on average assets was 0.74% and 0.73%, respectively. Return on average equity for the first six months of 2002 and 2001 was 7.98% and 9.04%, respectively. For the second quarter of 2002 and 2001, return on equity was 8.16% and 8.48%. Various profitability, liquidity and capital ratios are presented in Table 1. To understand the changes and trends in interest earning assets and interest bearing liabilities, refer to the average balance sheets and net interest income analysis presented in Table 2.
 
Net Interest Income.    The greatest portion of BancShares’ earnings is from net interest income, which is the difference between interest income on interest earning assets and interest paid on deposits and other interest bearing liabilities. The primary factors affecting net interest income are changes in the volume and yields/rates on interest earning assets and interest bearing liabilities, and the ability to respond to changes in interest rates through asset/liability management. For the first six months of 2002, net interest income was $18.1 million as compared to $18.4 million for the same period in 2001, a decrease of $236,000 or 1.28%. An increase in the volume of interest earning assets and interest bearing liabilities increased net interest income by $2.2 million. This was offset by the impact of rate changes which decreased net interest income by $2.4 million, which together with the $2.2 million increase, caused a decrease of $236,000 in net interest income. The net interest margin for the first six months of 2002 and 2001 was 4.11% and 4.38%, respectively. Net interest income and net interest margin for the second quarter of 2002 and 2001 were $9.2 million and 4.14% and $9.1 million and 4.22%, respectively.
 
Interest income for the first six months of 2002 was $28.1 million as compared to $34.4 million in 2001, a decrease of $6.4 million or 18.51%. The decrease in interest income for the first six months of 2002 over the first six months of 2001 is attributable to a decline in interest rates, the effect of which was offset partially by growth in average earning asset balances. Interest income from loans amounted to $25.2 million in the first six months of 2002 as compared to $28.9 million in the first six months of 2001, a decrease of $3.7 million or 12.67%. BancShares’ loan growth is largely due to growth within the existing branch network. Earnings from investments and federal funds sold provided the balance of interest income, contributing $2.8 million and $5.6 million for the

14

first six months of 2002 and 2001, respectively. Average interest earning assets for the first six months of 2002 increased to $891.4 million, a 5.17% increase, from $847.6 million in the first six months of 2001. The yield on interest earnings assets for the first six months of 2002 and 2001 was 6.36% and 8.21%, respectively. Trends in interest earning assets are shown in Table 2.
 
Interest expense for the first six months of 2002 was $9.9 million compared to $16.1 million in 2001, a decrease of $6.1 million or 38.19%. The decrease in interest expense in the first six months of 2002, compared to the first six months of 2001, is attributable to decreased interest rates on deposit balances, primarily time deposits and savings accounts. Average interest bearing deposits increased $19.3 million or 2.85%, from $675.3 million in the first six months of 2001 to $694.6 million in the first six months of 2002. The average rate paid on interest bearing deposits was 2.56% and 4.37% for the first six months of 2002 and 2001, respectively. Borrowings contributed $1.1 million in interest expense during the first six months of 2002 compared to $1.4 million during the first six months of 2001, a decrease of $338,000 or 23.4%. The yield on interest bearing liabilities for the first six months of 2002 and 2001 was 2.70% and 4.48%, respectively. Trends in interest bearing liabilities are shown in Table 2.
 
Asset Quality and Provision for Loan Losses.    Because BancShares’ loan portfolio represents its largest earning asset, BancShares continually monitors the quality of its loan portfolio. The Bank operates in a diversified economic environment and, in the opinion of management, is not unduly exposed to any one particular industry. For the second quarter of 2002 and 2001, management added $700,000 and $750,000, respectively, to the allowance for loan losses as provisions for loan losses. During the first six months of 2002, management charged-off loans totaling $1.3 million and had recoveries of $997,000 resulting in net charge-offs of $325,000. During the same period in 2001, management charged-off $787,000 in loans and had recoveries of $596,000, resulting in net charge-offs of $191,000. Charge-offs were higher for the first six months of 2002 than the same period of 2001 due to charge-offs of four loans. The ratio of allowance for loan losses to loans increased to 1.48% at June 30, 2002 from 1.39% at December 31, 2001. The following table presents BancShares’ comparative asset quality ratios:
 
    
June 30,
2002
       
December 31,
2001
  
Ratio of annualized net loans charged off to average loans
   
0.09
%
     
0.15
%
Allowance for loan losses to loans
   
1.48
 
     
1.39
 
Non-performing assets to total gross loans and other real estate owned
   
0.02
 
     
—  
 
Non-performing assets to total assets
   
0.02
 
     
—  
 
 
Management considers the June 30, 2002 allowance for loan losses adequate to cover probable losses inherent in the loan portfolio. Management’s periodic evaluation of the adequacy of the allowance is based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s experience, the estimated value of any underlying collateral, current economic conditions, analysis of peer bank trends, and other risk factors. Management believes it has established the allowance in accordance with accounting principles generally accepted in the United States of America and in consideration of the current economic environment. While management uses the best information available to make evaluations, future adjustments may be necessary if economic or other conditions differ substantially from the assumptions used. During the quarter, management continued to refine allocations of the allowance for loan losses to reflect trends in the loan portfolio.
 
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses and losses on other real estate owned. Such agencies may require the Bank to recognize adjustments to the allowances based on the examiners’ judgments about information available to them at the time of their examinations.
 
BancShares had no impaired loans at June 30, 2002. BancShares had non-accrual loans totaling $89,000 at June 30, 2002 and none at June 30, 2001. Management actively maintains a current loan watch list and knows of no other loans which are material and (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

15

 
Noninterest Income.    Noninterest income increased $114,000 or 2.32% for the first six months of 2002 over the first six months of 2001. Noninterest income, consisting primarily of service charges on deposit accounts and other service charges and fees, increased during the first six months of 2002 primarily due to the increased deposit base from three branch openings in the third and fourth quarters of 2001 as well as growth in the existing branch network. BancShares’ average deposits increased $38.7 million or 4.87% to $832.8 million in the first six months of 2002 from $794.2 million in the first six months of 2001. Noninterest income for the first six months of 2001 includes a securities gain of $501,478. This gain was recognized as a result of an exchange and subsequent sale of an equity investment. For the first six months of 2002, increases in noninterest income were partially offset by securities losses of $71,068, all of which were recognized in the second quarter. For the second quarter of 2002, noninterest income increased $118,000 or 4.81% over the same period of 2001.
 
Noninterest Expense.    Noninterest expense increased $229,000 or 1.42% from $16.1 million in the first six months of 2001 to $16.3 million in the first six months of 2002, including increases of $661,000 in salaries and employee benefits, $45,000 in occupancy and equipment expense, and $94,000 in data processing cost, which were offset by decreases of $231,000 in other expenses and $5,000 in intangibles amortization. The fluctuations represented increases of 7.84% in salaries and employee benefits, 1.88% in occupancy and equipment expenses, and 6.23% in data processing costs, which were offset by decreases of 9.00% in other expenses and 0.70% in intangibles amortization over the first six months of 2001. For the second quarter of 2002 noninterest expense increased $173,000 or 2.14% over the same period in 2001. Noninterest expense increased due to increased salaries from the three new branches opened in the second half of 2001 as well as increased activity within the existing branch network. BancShares also had an impairment loss of $477,972 on fixed assets during the six months ended June 30, 2001, of which $173,317 was recorded in the second quarter. During April 2001, BancShares analyzed the results of operations of two branches through the first three months of 2001 taking into consideration recent economic conditions and the projected performance of these branches. BancShares concluded the carrying value of these branches were impaired and therefore recorded an impairment loss of $304,656 in the first quarter of 2001 to reduce the carrying value of these branches to fair value. The fixed assets consisted primarily of leasehold improvements, which are deemed to have very minimal fair value. In the second quarter of 2001 the Board of Directors of BancShares approved to close these two branches and recorded an additional charge of $173,000 for the remaining lease payments and costs to close these branches. BancShares had an impairment loss of $143,224 in the second quarter of 2002. In May 2002, BancShares analyzed the operations of one branch since its inception in 1999 and determined that the loss experience would not turn around in the near future. The Board of Directors of BancShares approved to close this branch and at June 30, 2002, BancShares has accrued disposition costs which include $103,000 for losses on fixed assets, $20,000 for lease cancellation fees, and $20,000 for costs to close the branch.
 
Income Taxes.    In the first six months of 2002, BancShares had income tax expense of $1.9 million, a decrease of $156,000 or 7.52%, from $2.1 million in the first six months of 2001. The resulting effective income tax rates, based on the accruals for the six months ended June 30, 2002 and 2001, were 35.68% and 36.53%, respectively.
 
Capital Resources.
 
Shareholders’ Equity and Capital Adequacy.    Sufficient levels of capital are necessary to sustain growth and absorb losses. To this end, the Federal Reserve, which regulates BancShares, and the FDIC, which regulates the Bank, has established minimum capital guidelines for the institutions they supervise.
 
Regulatory guidelines define minimum requirements for BancShares’ leverage capital ratio. Leverage capital equals total equity and certain long-term borrowings less goodwill and certain other intangibles and is measured relative to total adjusted assets as defined by regulatory guidelines. According to these guidelines, BancShares’ leverage ratio at June 30, 2002 was 9.35% as compared to 8.99% at December 31, 2001.
 
BancShares is also required to meet minimum requirements for risk-based capital (“RBC”). BancShares’ assets, including loan commitments and other off-balance sheet items, are weighted according to federal guidelines for the risk considered inherent in each asset. At June 30, 2002, the Total Capital Ratio was 14.12% as compared to 14.03% at December 31, 2001.

16

 
The following table presents regulatory capital amounts calculations and ratios of BancShares:
 
    
June 30,
2002
   
December 31,
2001
    
(Dollars in thousands)
Tier 1 capital
   
$
89,598        
   
$
85,902        
Total capital
   
 
102,935        
   
 
98,245        
Leverage capital ratio
   
 
9.35%(1)
   
 
8.99%(1)
Tier 1 capital ratio
   
 
12.29   (1)
   
 
12.27   (1)
Total capital ratio
   
 
14.12   (1)
   
 
14.03   (1)
(1)
 
These ratios exceed the minimum required regulatory capital ratios.
 
At June 30, 2002, and December 31, 2001, BancShares was in compliance with its regulatory capital requirements, and all of its regulatory capital ratios exceed the minimum ratios required for it to be classified as “well capitalized.” Growth in BancShares’ assets resulting from acquisitions of branch offices and the opening of de novo branches has reduced, and is expected to continue to reduce, BancShares’ capital ratios.
 
Commitments, Contingencies and Off-balance sheet risk.
 
BancShares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying consolidated financial statements. Substantially all such instruments expire within one to three years.
 
BancShares’ risk of loss in the event of nonperformance by the other party to the commitment to extend credit, line of credit or standby letter of credit is represented by the contractual amount of these instruments. BancShares uses the same credit policies on the borrower in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, real estate and time deposits with financial institutions. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
 
As of June 30, 2002 and December 31, 2001, outstanding financial instruments whose contract amounts represent credit risk were as follows:
 
    
June 30,
2002
   
December 31, 2001
Outstanding commitments to lend, unfunded loans and lines of credit
   
$
229,366,319
   
221,656,178
    
  
Standby and commercial letters of credit
   
$
3,151,499
   
3,275,000
    
  
 
BancShares does not have any special purpose entities or other similar forms of off-balance sheet financing arrangements.
 
BancShares’ lending is concentrated primarily in central North Carolina and the surrounding communities in which it operates. Credit has been extended to certain of BancShares’ customers through multiple lending transactions; however, there is no concentration to any single customer or industry.
 
Liquidity, Market Risk and Interest Sensitivity.
 
Liquidity.    Liquidity refers to the ability of BancShares to generate sufficient funds to meet its financial obligations and commitments at a reasonable cost. Maintaining liquidity ensures that funds will be available for reserve requirements, customer demand for loans, withdrawal of deposit balances and maturities of other deposits and liabilities. Past experiences help management anticipate cyclical demands and amounts of cash required. These obligations can be met by existing cash reserves or funds from maturing loans and investments, but in the normal course of business are met by deposit growth.

17

 
In assessing liquidity, many relevant factors are considered, including stability of deposits, quality of assets, economy of the markets served, business concentration, competition and BancShares’ overall financial condition. BancShares’ liquid assets include all investment securities (minus pledged securities), overnight funds sold, interest bearing deposits in other banks and cash and due from banks. These assets represented 17.86% of deposits at June 30, 2002, a decrease from 22.08% at December 31, 2001. BancShares’ liquidity ratio, which is defined as cash plus short-term marketable securities (minus pledged securities) divided by deposits and short-term liabilities, was 17.35% at June 30, 2002, compared to 21.39% at December 31, 2001.
 
The consolidated statements of cash flows disclose the principal sources and uses of cash from operating, investing and financing activities for the six months ended June 30, 2002 and 2001. BancShares has no brokered deposits. Jumbo time deposits are considered to include all time deposits of $100,000 or more. BancShares has never aggressively bid on these deposits. Most jumbo deposit customers have other relationships with the Bank, including savings, demand and other time deposits, and in some cases, loans. At June 30, 2002, and December 31, 2001, jumbo time deposits represented 10.84% and 11.52%, respectively, of total deposits.
 
Management believes that BancShares has the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs, which arise, within realistic limitations, and management is not aware of any known demands, commitments or uncertainties that will affect liquidity in a material way.
 
BancShares has obligations under existing contractual obligations that will require payments in future periods. The following table presents aggregated information about such payments to be made in future periods. Transaction deposit accounts with indeterminate maturities have been classified as having payments due in less than one year.
 
CONTRACTUAL OBLIGATIONS
As of June 30, 2002
 
         
Payments due by period
     
    
Less than 1 year
   
1-3 years
   
4-5 years
   
Over 5 years
   
Total
    
(Dollars in thousands)
Deposits
   
$
757,238
   
73,907
   
10,754
   
—  
   
841,899
Short-term borrowings
   
 
24,529
   
—  
   
—  
   
—  
   
24,529
Long-term borrowings
   
 
—  
   
—  
   
—  
   
23,000
   
23,000
Lease obligations
   
 
343
   
442
   
123
   
905
   
1,813
    
  
  
  
  
Total contractual cash obligations
   
$
782,110
   
74,349
   
10,877
   
23,905
   
891,241
    
  
  
  
  
 
Market Risk.    Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. The risk of loss can be reflected in either diminished current market values or reduced potential net interest income in future periods.
 
BancShares’ market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. Management seeks to manage this risk through the use of short-term maturities. The composition and size of the investment portfolio is managed so as to reduce the interest rate risk in the deposit and loan portfolios while at the same time maximizing the yield generated by the portfolio.
 
The table below presents in tabular form the contractual balances and the estimated fair value of financial instruments at their expected maturity dates as of June 30, 2002. The expected maturity categories take into consideration historical prepayment experience as well as management’s expectations based on the interest rate environment as of June 30, 2002. For core deposits without contractual maturity (i.e. interest bearing checking, savings and money market accounts), the table presents principal cash flows as maturing in one year since they are subject to immediate repricing.

18

 
    
Maturing in period ended June 30,
              
    
2003
     
2004
     
2005
     
2006
     
2007
     
Thereafter
     
Total
     
Fair Value
    
(Dollars in thousands)
Assets
                                                                      
Loans:
                                                                      
Fixed rate
   
$
94,452
 
   
$
76,079
 
   
$
112,995
 
   
$
14,068
 
   
$
8,625
 
   
$
12,842
 
   
$
319,061
 
   
$
319,082
Average rate (%)
   
 
8.79
%
   
 
8.41
%
   
 
7.94
%
   
 
7.61
%
   
 
7.47
%
   
 
7.70
%
   
 
8.27
%
       
Variable rate
   
$
189,358
 
   
$
29,034
 
   
$
42,462
 
   
$
10,437
 
   
$
17,628
 
   
$
99,381
 
   
$
388,300
 
   
$
388,300
Average rate (%)
   
 
5.66
%
   
 
5.52
%
   
 
5.46
%
   
 
5.40
%
   
 
5.20
%
   
 
5.25
%
   
 
5.49
%
       
Investment securities(1):
                                                                      
Fixed rate
   
$
97,935
 
   
$
20,126
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
$
7
 
   
$
118,068
 
   
$
118,546
Average rate (%)
   
 
2.70
%
   
 
3.11
%
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
10.92
%
   
 
2.77
%
       
Liabilities
                                                                      
Savings and interest bearing checking:
                                                                      
Fixed rate
   
$
298,995
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
$
298,995
 
   
$
298,995
Average rate (%)
   
 
1.01
%
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
1.01
%
       
Certificates of deposit:
                                                                      
Fixed rate
   
$
306,837
 
   
$
50,159
 
   
$
23,748
 
   
$
10,754
 
   
 
—  
 
   
 
—  
 
   
$
391,498
 
   
$
395,559
Average rate (%)
   
 
3.04
%
   
 
4.07
%
   
 
4.87
%
   
 
5.01
%
   
 
—  
 
   
 
—  
 
   
 
3.34
%
       
Short-term obligations:
                                                                      
Variable rate
   
$
24,529
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
$
24,529
 
   
$
24,529
Average rate (%)
   
 
1.13
%
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
1.13
%
       
Long-term obligations:
                                                                      
Fixed rate
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
$
23,000
 
   
$
23,000
 
   
$
23,230
Average rate (%)
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
8.50
%
   
 
8.50
%
       
(1)
 
Marketable equity securities with a book value of approximately $3,566,009 and a fair value of approximately $12,917,315 have been excluded from this table.
 
Interest Sensitivity.    The table below presents BancShares interest sensitivity position at June 30, 2002. The difference between interest sensitive asset and interest sensitive liability repricing within time periods is referred to as the interest rate sensitivity gap. Assets and liabilities with maturities of one year or less and those that may be adjusted within the period are considered interest sensitive. The interest sensitivity position has meaning only as of the date for which it was prepared. Gaps are identified as either positive (interest sensitive assets in excess of interest sensitive liabilities) or negative (interest sensitive liabilities in excess of interest sensitive assets).
 
As of June 30, 2002, BancShares had a positive one-year cumulative gap position of 16.56% and a positive total cumulative gap position of 18.00%. At December 31, 2001, BancShares had a one-year positive cumulative gap position of 13.98% and a total positive cumulative gap position of 15.48%. The increase in the one-year cumulative gap position at June 30, 2002 is due to the repositioning of securities, which at December 31, 2001, would mature in greater than one year and at June 30, 2002, will mature in less than one year.

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June 30, 2002
  
    
1-30 Days Sensitive
     
31-90 Days Sensitive
     
91-180 Days Sensitive
     
181-365 Days Sensitive
     
Total One-Year Sensitive
     
Total Non Sensitive
     
Total
  
    
(Dollars in thousands)
  
Assets:
                                                               
Loans
   
$
369,084
 
   
$
41,009
 
   
$
14,456
 
   
$
28,911
 
   
$
453,460
 
   
$
253,901
 
   
$
707,361
 
Investment securities
   
 
60,011
 
   
 
—  
 
   
 
17,897
 
   
 
20,026
 
   
 
97,934
 
   
 
33,051
 
   
 
130,985
 
Overnight funds sold
   
 
34,800
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
34,800
 
   
 
—  
 
   
 
34,800
 
Other
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
2,468
 
   
 
2,468
 
Interest bearing deposits in other banks
   
 
24,376
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
24,376
 
   
 
—  
 
   
 
24,376
 
    
  
  
  
  
  
  
Total interest earning assets
   
$
488,271
 
   
$
41,009
 
   
$
32,353
 
   
$
48,937
 
   
$
610,570
 
   
$
289,420
 
   
$
899,990
 
    
  
  
  
  
  
  
Liabilities:
                                                               
Savings and checking with interest
   
$
—  
 
   
$
—  
 
   
$
—  
 
   
$
—  
 
   
$
—  
 
   
$
168,813
 
   
$
168,813
 
Money market savings
   
 
130,181
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
130,181
 
   
 
—  
 
   
 
130,181
 
Time deposits
   
 
56,311
 
   
 
69,672
 
   
 
91,860
 
   
 
88,994
 
   
 
306,837
 
   
 
84,661
 
   
 
391,498
 
Short-term borrowings
   
 
24,529
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
24,529
 
   
 
—  
 
   
 
24,529
 
Long-term borrowings
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
23,000
 
   
 
23,000
 
    
  
  
  
  
  
  
Total interest bearing liabilities
   
$
211,021
 
   
$
69,672
 
   
$
91,860
 
   
$
88,994
 
   
$
461,547
 
   
$
276,474
 
   
$
738,021
 
    
  
  
  
  
  
  
Interest-sensitivity gap
   
$
277,250
 
   
$
(28,663
)
   
$
(59,507
)
   
$
(40,057
)
   
$
149,023
 
   
$
12,946
 
   
$
161,969
 
    
  
  
  
  
  
  
Cumulative interest sensitivity gap
   
$
277,250
 
   
$
248,587
 
   
$
189,080
 
   
$
149,023
 
   
$
149,023
 
   
$
161,969
 
   
$
161,969
 
Cumulative interest sensitivity gap to total interest earning assets
   
 
30.81
%
   
 
27.62
%
   
 
21.01
%
   
 
16.56
%
   
 
16.56
%
   
 
18.00
%
   
 
18.00
%
 
Accounting and Other Matters.
 
In October 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 144 (Statement 144), “Accounting for the Impairment or Disposal of Long-Lived Assets”, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This standard provides guidance on differentiating between long-lived assets to be held and used, long-lived assets to be disposed of other than by sale and long-lived assets to be disposed of by sale. Statement 144 supersedes FASB Statement of Financial Accounting Standards No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”. Statement 144 also supersedes Accounting Principals Board Opinion No. 30, “Reporting the 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 is effective for fiscal years beginning after December 15, 2001. BancShares’ adoption of this statement did not have a material effect on its consolidated financial statements.
 
In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (Statement 146), “Accounting for Costs Associated with Exit or Disposal Activities,” which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” This Statement applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Those costs include, but are not limited to, the following: a) termination benefits provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that, in substance, is not an ongoing benefit arrangement or an individual deferred compensation contract (hereinafter referred to as one-time termination benefits), b) costs to terminate a contract that is not a capital

20

lease and c) costs to consolidate facilities or relocate employees. This Statement does not apply to costs associated with the retirement of a long-lived asset covered by FASB Statement No. 143, Accounting For Asset Retirement Obligations. A liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred. A liability for a cost associated with an exit or disposal activity is incurred when the definition of a liability is met. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The impact of adoption on BancShares is not known at this time.
 
Forward-Looking Statements
 
This discussion may contain statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of the qualifying words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate,” or other statements concerning opinions or judgments of BancShares and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of BancShares’ customers, actions of government regulators, the level of market interest rates, and general economic conditions.
 
ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 
This information is included in Item 2 in the text of BancShares’ Management Discussion and Analysis of Financial Condition and Results of Operations (under the caption “Liquidity, Market Risk and Interest Sensitivity”) and is incorporated herein by reference.
 
PART II.    OTHER INFORMATION
 
ITEM 6.    EXHIBITS AND REPORTS ON FORM 8K
 
(a) The following exhibits are included in or incorporated into this report.
 
 
3.1
 
BancShares’ Certificate of Incorporation (incorporated herein by reference to Exhibit 3.1 of BancShares’ Registration Statement No. 333-62225 filed with the SEC on August 26, 1998)
 
 
3.2
 
BancShares’ By-laws (incorporated herein by reference to Exhibit 3.2 of BancShares’ Registration Statement No. 333-62225 filed with the SEC on August 26, 1998)
 
 
4.1
 
Initial Trust Agreement of FIDBANK Capital Trust I, as amended (incorporated herein by reference to Exhibit 4.1 of BancShares’ Registration Statement No. 333-62225 filed with the SEC on August 26, 1998)
 
 
4.2
 
Certificate of Trust of FIDBANK Capital Trust I (incorporated herein by reference to Exhibit 4.2 of BancShares’ Registration Statement No. 333-62225 filed with the SEC on August 26, 1998)
 
 
4.3
 
Form of Amended and Restated Trust Agreement of FIDBANK Capital Trust I (incorporated herein by reference to Exhibit 4.3 of BancShares’ Amendment No. 3 to Registration Statement No. 333-62225 filed with the SEC on May 25, 1999)
 
 
4.4
 
Form of Capital Security Certificate for FIDBANK Capital Trust I (incorporated herein by reference to Exhibit 4.4 of BancShares’ Amendment No. 3 to Registration Statement No. 333-62225 filed with the SEC on May 25, 1999)
 
 
4.5
 
Form of Guarantee Agreement (incorporated herein by reference to Exhibit 4.5 of BancShares’ Amendment No. 3 to Registration Statement No. 333-62225 filed with the SEC on May 25, 1999)
 
 
4.6
 
Form of Junior Subordinated Indenture between BancShares and Bankers Trust Company, as Debenture Trustee (incorporated herein by reference to Exhibit 4.6 of BancShares’ Amendment No. 3 to Registration Statement No. 333-62225 filed with the SEC on May 25, 1999)
 
 
4.7
 
Form of Junior Subordinated Debenture (incorporated herein by reference to Exhibit 4.7 of BancShares’ Amendment No. 3 to Registration Statement No. 333-62225 filed with the SEC on May 25, 1999)
 
(b) No reports on Form 8-K were filed during the quarter ended June 30, 2002.

21

 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Dated: August 13, 2002
      
FIDELITY BANCSHARES (N.C.), INC.
           
By:
  
/s/    MARY W. WILLIS
               
Mary W. Willis
               
Chief Financial Officer and Treasurer
 
CERTIFICATION
(Pursuant to 18 U.S.C. Section 1350)
 
The undersigned hereby certifies that, (i) the foregoing Quarterly Report on Form 10-Q filed by Fidelity BancShares (N.C.), Inc. (the “Company”) for the quarter ended June 30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in that report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
By:
  
/s/    BILLY T. WOODARD
Date:
  
August 13, 2002
Billy T. Woodard
Chief Executive Officer
 
By:
  
/s/    MARY W. WILLIS
Date:
  
August 13, 2002
Mary W. Willis
Chief Financial Officer
 
 

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