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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2003
Commission File Number 0-13823
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FNB CORP.
(Exact name of Registrant as specified in its charter)
NORTH CAROLINA 56-1456589
(State of incorporation) (I.R.S. Employer Identification No.)
101 Sunset Avenue, Asheboro, North Carolina 27203
(Address of principal executive offices)
(336) 626-8300
(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 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act. Yes ___ No X
The registrant had 5,610,031 shares of $2.50 par value common stock outstanding
at May 2, 2003.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FNB CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, (unaudited)
---------------------------------- December 31,
2003 2002 2002
--------------- --------------- ---------------
(in thousands, except share data)
ASSETS
Cash and due from banks $ 22,727 $ 9,393 $ 15,944
Interest-bearing bank balances 33,742 - 14,819
Federal funds sold 12,576 12,383 26,819
Investment securities:
Available for sale, at estimated fair value (amortized
cost of $105,454, $170,287 and $125,151) 108,903 168,035 129,136
Held to maturity (estimated fair value of
$40,639 and $24,843) 40,703 - 24,721
Loans:
Loans held for sale 2,239 2,507 2,787
Loans held for investment 507,219 378,099 499,555
Less allowance for loan losses (6,169) (4,573) (6,109)
--------------- --------------- ---------------
Net loans 503,289 376,033 496,233
--------------- --------------- ---------------
Premises and equipment, net 14,240 10,428 14,071
Goodwill 12,601 - 12,601
Other assets 20,885 21,729 20,026
--------------- --------------- ---------------
Total Assets $ 769,666 $ 598,001 $ 754,370
=============== =============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand deposits $ 61,438 $ 54,002 $ 58,306
Interest-bearing deposits:
Demand, savings and money market deposits 215,583 152,545 207,271
Time deposits of $100,000 or more 115,843 110,345 113,776
Other time deposits 211,532 176,337 213,001
--------------- --------------- ---------------
Total deposits 604,396 493,229 592,354
Retail repurchase agreements 19,328 13,697 17,427
Federal Home Loan Bank advances 53,366 30,000 53,388
Other borrowed funds 11,000 - 11,000
Other liabilities 6,977 6,692 7,111
--------------- --------------- ---------------
Total Liabilities 695,067 543,618 681,280
--------------- --------------- ---------------
Shareholders' equity:
Preferred stock - $10.00 par value;
authorized 200,000 shares, none issued - - -
Common stock - $2.50 par value;
authorized 10,000,000 shares, issued shares -
5,486,219, 4,750,447 and 5,416,731 13,716 11,876 13,542
Surplus 9,019 - 8,823
Retained earnings 49,589 43,994 48,095
Accumulated other comprehensive income (loss) 2,275 (1,487) 2,630
--------------- --------------- ---------------
Total Shareholders' Equity 74,599 54,383 73,090
--------------- --------------- ---------------
Total Liabilities and Shareholders' Equity $ 796,666 $ 598,001 $ 754,370
=============== =============== ===============
See accompanying notes to consolidated financial statements.
2
FNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
March 31, (unaudited)
-------------------------------------
2003 2002
----------------- -----------------
(in thousands, except per share data)
INTEREST INCOME
Interest and fees on loans $ 8,161 $ 6,756
Interest and dividends on investment securities:
Taxable income 1,583 2,220
Non-taxable income 330 297
Other interest income 99 29
----------------- -----------------
Total interest income 10,173 9,302
----------------- -----------------
INTEREST EXPENSE
Deposits 2,693 3,108
Retail repurchase agreements 54 62
Federal Home Loan Bank advances 576 361
Federal funds purchased - 3
Other borrowed funds 98 -
----------------- -----------------
Total interest expense 3,421 3,534
----------------- -----------------
Net Interest Income 6,752 5,768
Provision for loan losses 250 510
----------------- -----------------
Net Interest Income After Provision for Loan Losses 6,502 5,258
----------------- -----------------
NONINTEREST INCOME
Service charges on deposit accounts 1,186 672
Annuity and brokerage commissions 102 54
Cardholder and merchant services income 190 164
Other service charges, commissions and fees 303 200
Bank owned life insurance 148 152
Net gain on sales of loans 678 412
Other income 156 34
----------------- -----------------
Total noninterest income 2,763 1,688
----------------- -----------------
NONINTEREST EXPENSE
Personnel expense 3,354 2,555
Net occupancy expense 334 247
Furniture and equipment expense 500 371
Data processing services 490 197
Other expense 1,335 1,055
----------------- -----------------
Total noninterest expense 6,013 4,425
----------------- -----------------
Income Before Income Taxes 3,252 2,521
Income taxes 990 716
----------------- -----------------
Net Income $ 2,262 $ 1,805
================= =================
Net income per common share:
Basic $ .42 $ .38
Diluted .40 .37
================= =================
Weighted average number of shares outstanding:
Basic 5,446,462 4,761,448
Diluted 5,708,381 4,869,589
================= =================
See accompanying notes to consolidated financial statements.
3
FNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Three Months Ended March 31, 2003 and March 31, 2002 (unaudited)
Accumulated
Common Stock Other
----------------------- Retained Comprehensive
Shares Amount Surplus Earnings Income (Loss) Total
---------- ---------- ---------- ---------- ------------- ----------
(in thousands, except share data)
Balance, December 31, 2001 4,763,261 $ 11,908 $ -- $ 43,032 $ 967 55,907
Comprehensive income:
Net income - - - 1,805 - 1,805
Other comprehensive income:
Unrealized securities losses,
net of income tax benefit of $1,263 - - - - (2,454) (2,454)
----------
Total comprehensive loss - - - - - (649)
----------
Cash dividends declared, $.14 per share - - - (662) - (662)
Common stock issued through:
Stock option plan 4,429 11 33 - - 44
Common stock reacquired through:
Stock buyback program (17,243) (43) (33) (181) - (257)
---------- ---------- ---------- ---------- ------------- ----------
Balance, March 31, 2002 4,750,447 $ 11,876 $ - $ 43,994 $ (1,487) $ 54,383
========== ========== ========== ========== ============= ==========
Balance, December 31, 2002 5,416,731 $ 13,542 $ 8,823 $ 48,095 $ 2,630 $ 73,090
Comprehensive income:
Net income - - - 2,262 - 2,262
Other comprehensive income:
Unrealized securities losses,
net of income tax benefit of $181 - - - - (355) (355)
----------
Total comprehensive income - - - - - 1,907
----------
Cash dividends declared, $.14 per share - - - (768) - (768)
Common stock issued through:
Stock option plan 78,980 198 368 - - 566
Common stock reacquired through:
Exchange related to issuance of option stock (9,492) (24) (172) - - (196)
---------- ---------- ---------- ---------- ------------- ----------
Balance, March 31, 2003 5,486,219 $ 13,716 $ 9,019 $ 49,589 $ 2,275 $ 74,599
========== ========== ========== ========== ============= ==========
See accompanying notes to consolidated financial statements.
4
FNB CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31, (unaudited)
-------------------------------------
2003 2002
----------------- -----------------
(in thousands)
OPERATING ACTIVITIES:
Net income $ 2,262 $ 1,805
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization of premises and equipment 427 306
Provision for loan losses 250 510
Deferred income taxes (benefit) (55) (10)
Deferred loan fees and costs, net 45 (71)
Premium amortization and discount accretion of
investment securities, net 115 9
Amortization of intangibles 19 -
Net decrease in loans held for sale 548 10,329
Increase in other assets (182) (661)
Increase (decrease) in other liabilities (128) 48
----------------- -----------------
Net Cash Provided by Operating Activities 3,301 12,265
----------------- -----------------
INVESTING ACTIVITIES:
Available-for-sale securities:
Proceeds from maturities and calls 19,588 9,091
Purchases (500) (17,711)
Held-to-maturity securities:
Proceeds from maturities and calls 12,000 -
Purchases (28,006) -
Net decrease (increase) in loans held for investment (8,177) 131
Purchases of premises and equipment (615) (492)
Other, net 298 15
----------------- -----------------
Net Cash Used in Investing Activities (5,412) (8,966)
----------------- -----------------
FINANCING ACTIVITIES:
Net increase in deposits 12,170 12,999
Increase (decrease) in retail repurchase agreements 1,901 (1,115)
Decrease in federal funds purchased - (6,000)
Common stock issued 370 44
Common stock repurchased - (257)
Cash dividends paid (867) (811)
----------------- -----------------
Net Cash Provided by Financing Activities 13,574 4,860
----------------- -----------------
Net Increase in Cash and Cash Equivalents 11,463 8,159
Cash and cash equivalents at beginning of period 57,582 13,617
----------------- -----------------
Cash and Cash Equivalents at End of Period $ 69,045 $ 21,776
================= =================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 3,434 $ 4,169
Income taxes (refund) 161 (63)
Noncash transactions:
Foreclosed loans transferred to other real estate 135 168
Cashless exercise of stock options 196 -
Unrealized securities losses, net of income taxes (355) (2,454)
See accompanying notes to consolidated financial statements.
5
FNB CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
FNB Corp. is a multi-bank holding company whose wholly-owned
subsidiaries are the First National Bank and Trust Company ("First
National Bank") and Rowan Savings Bank SSB, Inc. ("Rowan Bank"). First
National Bank and Rowan Bank are collectively referred to as the
"subsidiary banks". First National Bank has one wholly-owned
subsidiary, First National Investor Services, Inc. Through its
subsidiaries, FNB Corp. offers a complete line of consumer, mortgage
and business banking services, including loan, deposit, cash
management, investment management and trust services, to individual and
business customers primarily in the region of North Carolina that
includes Chatham, Montgomery, Moore, Randolph, Richmond, Rowan and
Scotland counties.
The accompanying consolidated financial statements, prepared without
audit, include the accounts of FNB Corp. and its subsidiaries
(collectively the "Corporation"). All significant intercompany balances
and transactions have been eliminated. The chief operating decision
maker reviews the results of operations of the Corporation and its
subsidiaries as a single enterprise.
The preparation of the consolidated 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 disclosure of
contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.
2. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, amounts due from banks, and federal funds sold.
Generally, federal funds are purchased and sold for one-day periods.
3. MERGER INFORMATION
ROWAN BANCORP, INC.
On August 1, 2002, the Corporation completed a merger for the
acquisition of Rowan Bancorp, Inc. ("Rowan Bancorp"), holding company
for Rowan Savings Bank SSB, Inc. ("Rowan Bank"), headquartered in China
Grove, North Carolina. Per the terms of the merger agreement, Rowan
Bank will be operated as a separate subsidiary of FNB Corp. for a
period of not less than 24 months; provided, however, that the Board of
Directors of Rowan Bank may elect to cause Rowan Bank to merge with
First National Bank or another subsidiary of FNB Corp. prior to the
termination of the 24-month period. At the date of merger, Rowan Bank
operated three offices and, based on estimated fair values, had
$134,208,000 in total assets, $95,738,000 in loans and $101,205,000 in
deposits.
6
Pursuant to the terms of the merger, each share of Rowan Bancorp common
stock was converted into either 2.3715 shares of FNB Corp. common stock
or $36.00 in cash or a combination of stock and cash, the overall
conversion to stock being limited to 45% of Rowan Bancorp shares. The
aggregate purchase price was $21,830,000, consisting of $11,205,000 of
cash payments, 603,859 shares of FNB Corp. common stock valued at
$9,094,000 and outstanding Rowan Bancorp stock options valued at
$1,531,000.
The merger transaction has been accounted for using the purchase method
of accounting for business combinations, and accordingly, the assets
and liabilities of Rowan Bank were recorded based on a preliminary
estimate of fair values as of August 1, 2002, subject to possible
adjustment during the one-year period from that date. The consolidated
financial statements include the results of operations of Rowan Bank
since August 1, 2002. Premiums and discounts that resulted from
recording the Rowan Bancorp assets and liabilities at their respective
fair values are being amortized using methods that approximate an
effective yield over the life of the assets and liabilities. The net
amortization increased net income before income taxes by $74,000 in the
three months ended March 31, 2003.
DOVER MORTGAGE COMPANY (Unaudited)
On February 20, 2003, the Corporation entered into a definitive merger
agreement to acquire Dover Mortgage Company ("Dover"), headquartered in
Charlotte, North Carolina. Dover originates, underwrites and closes
mortgage loans for sale into the secondary market. Mortgage production
is sold on a service-released basis to a number of national lenders who
in turn service the loans. Under the terms of the agreement, Dover will
be merged with a wholly owned subsidiary of FNB Corp. formed for the
purposes of effecting the merger. Dover will then become a separate
subsidiary of FNB Corp. The merger will be accounted for using the
purchase method of accounting for business combinations and is subject
to several conditions, including approval by applicable regulatory
authorities. Upon satisfaction of these conditions, the merger is
anticipated to close early in the second quarter of 2003. Dover
shareholders will receive a combination of common stock and cash. The
merger agreement provides that generally 50% of the outstanding shares
of Dover common stock will be converted into FNB Corp. common stock and
the remaining 50% will be converted into cash. Subject to a maximum
total payment, Dover shareholders will be entitled to additional cash
consideration over the four-year period following closing, based on a
percentage of Dover's pretax net income during that four-year period.
Any additional cash consideration paid to Dover shareholders will be
recorded as an adjustment to goodwill. At March 31, 2003, Dover
operated six mortgage loan production offices and had approximately
$42,302,000 in total assets and $1,630,000 in shareholders' equity.
4. EARNINGS PER SHARE (EPS)
Basic net income per share, or basic earnings per share (EPS), is
computed by dividing net income by the weighted average number of
common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if the Corporation's dilutive stock
options were exercised. The numerator of the basic EPS computation is
the same as the numerator of the diluted EPS computation for all
periods presented. A reconciliation of the denominators of the basic
and diluted EPS computations is as follows:
7
Three Months Ended
March 31,
-----------------------
2003 2002
---------- ----------
Basic EPS denominator - Weighted average
number of common shares outstanding 5,446,462 4,761,448
Dilutive share effect arising from assumed
exercise of stock options 261,919 108,141
---------- ----------
Diluted EPS denominator 5,708,381 4,869,589
========== ==========
For the three months ended March 31, 2003 and 2002, there were 2,500
and 10,233 stock options, respectively, that were antidilutive since
the exercise price exceeded the average market price. These common
stock equivalents were omitted from the calculations of diluted EPS for
their respective periods.
5. STOCK OPTIONS
The Corporation accounts for awards under employee stock-based
compensation plans using the intrinsic value method in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees" and,
accordingly, no compensation cost has been recognized for such awards
in the consolidated financial statements. The pro forma effect on net
income and earnings per share as if the compensation cost that would
have been determined under the fair value method had been recorded in
the consolidated financial statements, pursuant to the provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" and Statement No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of
FASB Statement No. 123", is disclosed as follows, for stock option
grants in 1995 and subsequent years.
Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
(in thousands, except
per share data)
Net income, as reported $ 2,262 $ 1,805
Less: Stock-based compensation cost determined
under fair value method, net of related tax effects 85 85
---------- ----------
Net income, pro forma $ 2,177 $ 1,720
========== ==========
Net income per share:
Basic:
As reported $ .42 $ .38
Pro forma .40 .36
Diluted:
As reported .40 .37
Pro forma .38 .35
8
6. LOANS
Loans as presented are reduced by net deferred loan fees of $826,000,
$443,000 and $781,000 at March 31, 2003, March 31, 2002 and December
31, 2002, respectively.
7. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses were as follows:
Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
(in thousands)
Balance at beginning of period $ 6,109 $ 4,417
Charge-offs 214 383
Recoveries 24 29
---------- ----------
Net loan charge-offs 190 354
Provision for loan losses 250 510
---------- ----------
Balance at end of period $ 6,169 $ 4,573
========== ==========
8. SUPPLEMENTARY INCOME STATEMENT INFORMATION
Significant components of other expense were as follows:
Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
(in thousands)
Stationery, printing and supplies $ 154 $ 128
Advertising and marketing 118 103
9
9. INTANGIBLE ASSETS
BUSINESS COMBINATIONS
For intangible assets related to business combinations, the following
is a summary of the gross carrying amount and accumulated amortization
of amortized intangible assets and the carrying amount of unamortized
intangible assets:
March 31,
--------------------- December 31,
2003 2002 2002
--------- ---------- ------------
(in thousands)
Amortized intangible assets:
Core deposit premium related
to whole bank acquisition:
Carrying amount $ 256 $ - $ 256
Accumulated amortization 49 - 30
------- ------- -------
Net core deposit premium $ 207 $ - $ 226
======= ======= =======
Unamortized intangible assets:
Goodwill - Carrying amount $12,601 $ - $12,601
======= ======= =======
Amortization of intangibles totaled $30,000 for core deposit premiums
in 2002 and $19,000 for the three months ended March 31, 2003. The
estimated amortization expense for core deposit premiums for the years
ending after December 31, 2002 is as follows: $68,000 in 2003, $56,000
in 2004, $44,000 in 2005, $32,000 in 2006, $19,000 in 2007 and $7,000
in 2008.
MORTGAGE SERVICING RIGHTS
The following is an analysis of mortgage servicing rights included in
other assets on the consolidated balance sheet:
Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
(in thousands)
Balance at beginning of period $ 1,052 $ 482
Servicing rights capitalized 223 269
Amortization expense 67 32
Change in valuation allowance - -
---------- ----------
Balance at end of period $ 1,208 $ 719
========== ==========
The estimated amortization expense for mortgage servicing rights for
the years ending after December 31, 2002 is as follows: $347,000 in
2003, $347,000 in 2004, $347,000 in 2005 and $11,000 in 2006. The
estimated amortization expense is based on current information at
December 31, 2002 regarding
10
loan payments and prepayments. Amortization expense could change in
future periods based on changes in the volume of prepayments and
economic factors.
10. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENT - GUARANTOR'S ACCOUNTING AND
DISCLOSURE REQUIREMENTS FOR GUARANTEES
In November 2002, the FASB issued Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FASB Interpretation No. 45"), which addresses
the disclosure to be made by a guarantor in its interim and annual
financial statements about its obligations under guarantees. FASB
Interpretation No. 45 requires the guarantor to recognize a liability
for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified
triggering events or conditions occur. The initial measurement of this
liability is the fair value of the guarantee at inception. The
recognition of the liability is required even if it is not probable
that payments will be required under the guarantee or if the guarantee
was issued with a premium payment or as part of a transaction with
multiple elements. The disclosure requirements are effective for
interim and annual financial statements ending after December 15, 2002.
The initial recognition and measurement provisions are effective for
all guarantees within the scope of FASB Interpretation No. 45 issued or
modified after December 31, 2002.
The Corporation issues standby letters of credit whereby the
Corporation guarantees the performance of a customer to a third party
if a specified triggering event or condition occurs. The guarantees
generally expire within one year and may be automatically renewed
depending on the terms of the guarantee. All standby letters of credit
provide for recourse against the customer on whose behalf the letter of
credit was issued, and this recourse may be further secured by a pledge
of assets.
At March 31, 2003, the maximum potential amount of undiscounted future
payments related to standby letters of credit was $106,000. Due to
insignificance, the Corporation has recorded no liability at March 31,
2003 for the current carrying amount of the obligation to perform as a
guarantor.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of this discussion and analysis is to assist in the
understanding and evaluation of the financial condition, changes in financial
condition and results of operations of FNB Corp. (the "Parent Company") and its
wholly-owned subsidiaries, First National Bank and Trust Company ("First
National Bank") and Rowan Savings Bank SSB, Inc. ("Rowan Bank"), collectively
referred to as the "Corporation". This discussion should be read in conjunction
with the financial information appearing elsewhere in this report.
OVERVIEW
On August 1, 2002, the Corporation completed a merger for the
acquisition of Rowan Bancorp, Inc. ("Rowan Bancorp"), holding company for Rowan
Savings Bank SSB, Inc. ("Rowan Bank"), headquartered in China Grove, North
Carolina. Per the terms of the merger agreement, Rowan Bank will be operated as
a separate subsidiary of FNB Corp. for a period of not less than 24 months;
provided, however, that the Board of Directors of Rowan Bank may elect to cause
Rowan Bank to merge with First National Bank or another subsidiary of FNB Corp.
prior to the termination of the 24-month period. At the date of merger, Rowan
Bank operated three offices and, based on estimated fair values, had
$134,208,000 in total assets, $95,738,000 in loans and $101,205,000 in deposits.
Pursuant to the terms of the merger, each share of Rowan Bancorp common stock
was converted into either 2.3715 shares of FNB Corp. common stock or $36.00 in
cash or a combination of stock and cash, the overall conversion to stock being
limited to 45% of Rowan Bancorp shares. The aggregate purchase price was
$21,830,000, consisting of $11,205,000 of cash payments, 603,859 shares of FNB
Corp. common stock valued at $9,094,000 and outstanding Rowan Bancorp stock
options valued at $1,531,000. The merger transaction has been accounted for
using the purchase method of accounting for business combinations, and
accordingly, the assets and liabilities of Rowan Bank were recorded based on a
preliminary estimate of fair values as of August 1, 2002, subject to possible
adjustment during the one-year period from that date. The consolidated financial
statements include the results of operations of Rowan Bank since August 1, 2002.
On February 20, 2003, the Corporation entered into a definitive merger
agreement to acquire Dover Mortgage Company ("Dover"), headquartered in
Charlotte, North Carolina. Dover originates, underwrites and closes mortgage
loans for sale into the secondary market. Mortgage production is sold on a
service-released basis to a number of national lenders who in turn service the
loans. Under the terms of the agreement, Dover will be merged with a wholly
owned subsidiary of FNB Corp. formed for the purposes of effecting the merger.
Dover will then become a separate subsidiary of FNB Corp. The merger will be
accounted for using the purchase method of accounting for business combinations
and is subject to several conditions, including approval by applicable
regulatory authorities. Upon satisfaction of these conditions, the merger is
anticipated to close early in the second quarter of 2003. Dover shareholders
will receive a combination of common stock and cash. The merger agreement
provides that generally 50% of the outstanding shares of Dover common stock will
be converted into FNB Corp. common stock and the remaining 50% will be converted
into cash. Subject to a maximum total payment, Dover shareholders will be
entitled to additional cash consideration over the four-year period following
closing, based on a percentage of Dover's pretax net income during that
four-year period. At December 31, 2002, Dover operated six mortgage loan
production offices and had approximately $44,961,000 in total assets and
$2,204,000 in shareholders' equity.
12
The Corporation earned $2,262,000 in the first quarter of 2003, a 25.3%
increase over the same period in 2002. Basic earnings per share increased from
$.38 to $.42 and diluted earnings per share increased from $.37 to $.40 for
percentage increases of 10.5% and 8.1%, respectively. As noted above, Rowan Bank
was acquired as a subsidiary through a merger effective August 1, 2002,
impacting both net income and the calculation of earnings per share since that
time. Total assets were $769,666,000 at March 31, 2003, up 28.7% from March 31,
2002, largely reflecting the acquisition of Rowan Bank, and up 2.0% from
December 31, 2002. Loans amounted to $509,458,000 at March 31 2003, increasing
33.9% from March 31, 2002 and 1.4% from December 31, 2002. Total deposits were
up 22.5% from March 31, 2002 and 2.0% from December 31, 2002, amounting to
$604,396,000 at March 31, 2003.
CRITICAL ACCOUNTING POLICIES
The Corporation's significant accounting policies are set forth in Note
1 to the Consolidated Financial Statements contained in the Form 10-K Annual
Report for the fiscal year ended December 31, 2002. Of these significant
accounting policies, the Corporation considers its policy regarding the
allowance for loan losses to be its most 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. The Corporation 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. The Corporation's 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 the Corporation's allowance for loan losses
and related matters, see "Asset Quality".
EARNINGS REVIEW
The Corporation's net income increased $457,000 or 25.3% in the first
quarter of 2003 compared to the same period of 2002, reflecting in part the
acquisition of Rowan Bank on August 1, 2002 as discussed above. Earnings were
positively impacted in the first quarter of 2003 by increases of $984,000 in net
interest income and $1,075,000 in noninterest income and by a $260,000 reduction
in the provision for loan losses. These gains were significantly offset,
however, by a $1,588,000 increase in noninterest expense. Noninterest income has
been favorably impacted by the increase in service charges on deposit accounts
resulting from the implementation of an overdraft protection program in July
2002 and by the increase in the net gain on sales of loans as long-term
conforming mortgage rates have remained at historical lows.
On an annualized basis, return on average assets decreased from 1.21%
in the first quarter of 2002 to 1.20% in the first quarter of 2003. Return on
average shareholders' equity decreased from 12.68% to 12.23% in comparing the
same periods. In the first quarter of 2003, return on tangible assets and equity
(calculated by deducting average goodwill from average assets and from average
equity) amounted to 1.22% and 14.74%, respectively.
NET INTEREST INCOME
Net interest income is the difference between interest income,
principally from loans and investments, and interest expense, principally on
customer deposits. Changes in net interest income result from changes in
interest rates and in the volume, or average dollar level, and mix of earning
assets and interest-bearing liabilities.
13
Net interest income was $6,752,000 in the first quarter of 2003
compared to $5,768,000 in the same period of 2002. This increase of $984,000 or
17.1% was largely due to the acquisition of Rowan Bank on August 1, 2002 as
discussed above, which was the primary factor resulting in a 25.0% increase in
the level of average earning assets, the effect of which was partially offset by
a decline in the net yield on earning assets, or net interest margin, from 4.43%
in the first quarter of 2002 to 4.11% in the same period of 2003. On a taxable
equivalent basis, the increase in net interest income in the first quarter of
2003 was $968,000, reflecting changes in the relative mix of taxable and
non-taxable earning assets in each period.
Table 1 on page 24 sets forth for the periods indicated information
with respect to the Corporation's average balances of assets and liabilities, as
well as the total dollar amounts of interest income (taxable equivalent basis)
from earning assets and interest expense on interest-bearing liabilities,
resultant rates earned or paid, net interest income, net interest spread and net
yield on earning assets. Net interest spread refers to the difference between
the average yield on earning assets and the average rate paid on
interest-bearing liabilities. Net yield on earning assets, or net interest
margin, refers to net interest income divided by average earning assets and is
influenced by the level and relative mix of earning assets and interest-bearing
liabilities. Changes in net interest income on a taxable equivalent basis, as
measured by volume and rate variances, are also analyzed in Table 1. Volume
refers to the average dollar level of earning assets and interest-bearing
liabilities.
Changes in the net interest margin and net interest spread tend to
correlate with movements in the prime rate of interest. There are variations,
however, in the degree and timing of rate changes, compared to prime, for the
different types of earning assets and interest-bearing liabilities.
Until the significant interest rate declines in 2001, there had been a
much greater degree of stability for several years in the interest rates both
earned and paid by the Corporation. After rate cuts totaling 4.75% in 2001 and
an additional rate cut of .50% in 2002, the prime rate averaged 6.99% in 2001
and 4.67% in 2002 compared to the average prime rates of 9.21%, 7.99% and 8.37%
in 2000, 1999 and 1998, respectively. Due to a general slowdown in the economy
that began to be perceived in the 2000 fourth quarter, the Federal Reserve acted
to provide a stimulus through a series of interest rate reductions commencing in
the 2001 first quarter, resulting in eight 50 basis point reductions and three
25 basis point reductions in the prime rate that lowered it to the 4.75% level
at December 31, 2001. The reductions in the prime rate tended to negatively
impact the net interest margin and net interest spread until the 2001 third
quarter when these measures began to improve. An additional rate cut of 50 basis
points in November 2002 further lowered the prime rate to the 4.25% level at
December 31, 2002.
The Corporation's net interest margin and net interest spread have been
negatively impacted in 2003 due in part to the last reduction in the prime rate
in November 2002 but also because of the cumulative effect of the reductions in
yields on fixed rate earning assets over an extended period.
The prime rate averaged 4.25% in the first quarter of 2003 compared to
4.75% in the 2002 first quarter. The net interest spread, in comparing first
quarter periods, declined by 17 basis points from 4.02% in 2002 to 3.85% in 2003
reflecting the effect of a decrease in the average total yield on earning assets
that more than offset the decrease in the average rate paid on interest-bearing
liabilities, or cost of funds. The yield on earning assets decreased by 91 basis
points from 7.01% in 2002 to 6.10% in 2003, while the cost of funds decreased by
74 basis points from 2.99% to 2.25%.
14
PROVISION FOR LOAN LOSSES
This provision is the charge against earnings to provide an allowance
or reserve for probable losses inherent in the loan portfolio. The amount of
each period's charge is affected by several considerations including
management's evaluation of various risk factors in determining the adequacy of
the allowance (see "Asset Quality"), actual loan loss experience and loan
portfolio growth. Earnings were positively impacted in the first quarter of 2003
by a $260,000 decrease in the provision.
The allowance for loan losses, as a percentage of loans held for
investment, amounted to 1.22% at March 31, 2003, 1.21% at March 31, 2002 and
1.22% at December 31, 2002. The level of the allowance and the resulting
percentage relationship to loans held for investment has been influenced in
recent periods by asset quality considerations, increases in historical
charge-off trends and general economic conditions.
NONINTEREST INCOME
Noninterest income increased $1,075,000 or 63.7% in the first quarter
of 2003 compared to the same period in 2002, reflecting in part the acquisition
of Rowan Bank on August 1, 2002 as discussed above and also the general increase
in the volume of business. The increase was primarily due to a $514,000 increase
in service charges on deposit accounts and to a $266,000 increase in the net
gain on sales of loans. The increase in service charges on deposit accounts was
primarily due to the implementation of an overdraft protection program in July
2002. Other factors favorably affecting the level of service charges on deposit
accounts in 2003 were the selected increases in service charge rates that became
effective in the 2002 third quarter and the increase in the level of deposit
accounts subject to service charges. The net gain on sales of loans was affected
in 2003 by long-term conforming mortgage rates that have remained at historical
lows.
NONINTEREST EXPENSE
Noninterest expense was $1,588,000 or 35.9% higher in the first quarter
of 2003 compared to the same period in 2002, due in part to the acquisition of
Rowan Bank on August 1, 2002 as discussed above. The largest factor resulting in
higher noninterest expense was the generally increased level of personnel
expense, which was impacted by increased staffing requirements in addition to
what was attributable to the initial acquisition of Rowan Bank, by normal salary
adjustments and by higher costs of fringe benefits. The cost of data processing
services was higher in 2003 because of the outside data processing services
employed by Rowan Bank until the conversion to an in-house system in March 2003,
with the conversion project separately resulting in $140,000 in expenses. Other
expense was affected in 2003 by expenses related to the new overdraft protection
program (see "Noninterest Income").
INCOME TAXES
The effective income tax rate increased from 28.4% in the first quarter
of 2002 to 30.4% in the same period of 2003 due principally to an increase in
the ratio of taxable to non-taxable income.
LIQUIDITY
Liquidity refers to the continuing ability of the subsidiary banks to
meet deposit withdrawals, fund loan and capital expenditure commitments,
maintain reserve requirements, pay operating expenses and provide funds to the
Parent Company for payment of dividends, debt service and other operational
requirements. Liquidity is immediately available from five major sources: (a)
cash on hand and on deposit at
15
other banks, (b) the outstanding balance of federal funds sold, (c) lines for
the purchase of federal funds from other banks, (d) the lines of credit
established at the Federal Home Loan Bank totaling $103,400,000, less existing
advances against those lines, and (e) the investment securities portfolio. All
debt securities are of investment grade quality and, if the need arises, can be
promptly liquidated on the open market or pledged as collateral for short-term
borrowing.
Consistent with the general approach to liquidity, the subsidiary banks
as a matter of policy do not solicit or accept brokered deposits for funding
asset growth. Instead, loans and other assets are based primarily on a core of
local deposits and the subsidiary bank's capital position. To date, the steady
increase in deposits, retail repurchase agreements and capital, supplemented by
Federal Home Loan Bank advances, has been adequate to fund loan demand in each
subsidiary bank's market area, while maintaining the desired level of immediate
liquidity and a substantial investment securities portfolio available for both
immediate and secondary liquidity purposes.
COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK
In the normal course of business, various commitments are outstanding
that are not reflected in the consolidated financial statements. Significant
commitments at March 31, 2003 are discussed below.
Commitments to extend credit and undisbursed advances on customer lines
of credit are agreements to lend to a customer as long as there is no violation
of any condition established in the contract. At March 31, 2003, total
commitments to extend credit and undisbursed advances on customer lines of
credit amounted to $149,640,000. Commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. Since many
commitments expire without being drawn, the total commitment amounts do not
necessarily represent future cash requirements. The Corporation evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary, upon extension of credit is based on the credit
evaluation of the borrower.
Standby letters of credit are commitments issued by the Corporation to
guarantee the performance of a customer to a third party. At March 31, 2003, the
maximum potential amount of undiscounted future payments related to standby
letters of credit was $106,000. Due to insignificance, the Corporation has
recorded no liability at March 31, 2003 for the current carrying amount of the
obligation to perform as a guarantor. All standby letters of credit provide for
recourse against the customer on whose behalf the letter of credit was issued,
and this recourse may be further secured by a pledge of assets.
Binding commitments for the origination of mortgage loans intended to
be held for sale at March 31, 2003 were not material. There were no such binding
commitments at March 31, 2002.
The Corporation does not have any special purpose entities or other
similar forms of off-balance sheet financing.
ASSET/LIABILITY MANAGEMENT AND INTEREST RATE SENSITIVITY
One of the primary objectives of asset/liability management is to
maximize the net interest margin while minimizing the earnings risk associated
with changes in interest rates. One method used to manage interest rate
sensitivity is to measure, over various time periods, the interest rate
sensitivity positions, or gaps; however, this method addresses only the
magnitude of timing differences and does not address earnings or market value.
Therefore, management uses an earnings simulation model to prepare, on a regular
basis,
16
earnings projections based on a range of interest rate scenarios in order to
more accurately measure interest rate risk.
The Corporation's balance sheet was liability-sensitive at March 31,
2003. A liability-sensitive position means that, for cumulative gap measurement
periods of one year or less, there are more liabilities than assets subject to
immediate repricing as market rates change. Because immediately rate sensitive
interest-bearing liabilities exceed rate sensitive assets, the earnings position
could improve in a declining rate environment and could deteriorate in a rising
rate environment, depending on the correlation of rate changes in these two
categories. Included in interest-bearing liabilities subject to rate changes
within 90 days is a portion of the interest-bearing demand, savings and money
market deposits. These types of deposits historically have not repriced
coincidentally with or in the same proportion as general market indicators.
CAPITAL ADEQUACY
Under guidelines established by the Board of Governors of the Federal
Reserve System, capital adequacy is currently measured for regulatory purposes
by certain risk-based capital ratios, supplemented by a leverage capital ratio.
The risk-based capital ratios are determined by expressing allowable capital
amounts, defined in terms of Tier 1, Tier 2 and Tier 3, as a percentage of
risk-weighted assets, which are computed by measuring the relative credit risk
of both the asset categories on the balance sheet and various off-balance sheet
exposures. Tier 1 capital consists primarily of common shareholders' equity and
qualifying perpetual preferred stock, net of goodwill and other disallowed
intangible assets. Tier 2 capital, which is limited to the total of Tier 1
capital, includes allowable amounts of subordinated debt, mandatory convertible
debt, preferred stock and the allowance for loan losses. Tier 3 capital,
applicable only to financial institutions subject to certain market risk capital
guidelines, is capital allocated to support the market risk related to a
financial institution's ongoing trading activities. At March 31, 2003, FNB Corp.
and each of the subsidiary banks were not subject to the market risk capital
guidelines and, accordingly, had no Tier 3 capital allocation. Total capital,
for risk-based purposes, consists of the sum of Tier 1, Tier 2 and Tier 3
capital. Under current requirements, the minimum total capital ratio is 8.00%
and the minimum Tier 1 capital ratio is 4.00%. At March 31, 2003, FNB Corp. had
a total capital ratio of 12.00% and a Tier 1 capital ratio of 10.87%. First
National Bank and Rowan Bank had total capital ratios of 13.21% and 13.56%,
respectively, and Tier 1 capital ratios of 12.11% and 12.31%, respectively.
The leverage capital ratio, which serves as a minimum capital standard,
considers Tier 1 capital only and is expressed as a percentage of average total
assets for the most recent quarter, after reduction of those assets for goodwill
and other disallowed intangible assets at the measurement date. As currently
required, the minimum leverage capital ratio is 4.00%. At March 31, 2003, FNB
Corp. had a leverage capital ratio of 8.05%. First National Bank and Rowan Bank
had leverage capital ratios of 9.15% and 8.15%, respectively.
First National Bank and Rowan Bank are also required to comply with
prompt corrective action provisions established by the Federal Deposit Insurance
Corporation Improvement Act. To be categorized as well-capitalized, a bank must
have a minimum ratio for total capital of 10.00%, for Tier 1 capital of 6.00%
and for leverage capital of 5.00%. As noted above, both First National Bank and
Rowan Bank met all of those ratio requirements at March 31, 2003 and,
accordingly, are well-capitalized under the regulatory framework for prompt
corrective action.
17
BALANCE SHEET REVIEW
Total assets at March 31, 2003 were $171,665,000 or 28.7% higher than
at March 31, 2002, largely reflecting the acquisition of Rowan Bank as discussed
in the "Overview", and were $15,296,000 or 2.0% higher than at December 31,
2002. Similarly, deposits were ahead by $111,167,000 or 22.5% and $12,042,000 or
2.0%. The level of total assets was also affected by advances from the Federal
Home Loan Bank to First National Bank, which at March 31, 2003 had increased by
$15,000,000 compared to March 31, 2002 and was unchanged compared to December
31, 2002. Additionally, the level of Federal Home Loan Bank advances was further
increased by advances totaling $8,000,000, exclusive of fair value adjustments,
which resulted from the Rowan Bank acquisition. The level of funds provided by
retail repurchase agreements at March 31, 2003 had increased by $5,631,000 from
March 31, 2002 and by $1,901,000 from December 31, 2002. Average assets
increased 26.9% in the first quarter of 2003 compared to the same period in
2002, while average deposits increased 21.4%.
INVESTMENT SECURITIES
Additions to the investment securities portfolio depend to a large
extent on the availability of investable funds that are not otherwise needed to
satisfy loan demand. In general, because of economic and interest rate
uncertainties, a higher than normal level of the proceeds from investment
maturities and calls were held in a liquid status at March 31, 2003, leading to
a $18,429,000 or 11.0% reduction in the level of investment securities compared
to March 31, 2002. Investable funds not otherwise utilized are temporarily
invested as federal funds sold or as interest-bearing balances at other banks,
the level of which is affected by such considerations as near-term loan demand
and liquidity needs. As noted above, the level of funds temporarily invested as
federal funds sold or as interest-bearing balances at other banks was higher
than normal at March 31, 2003.
LOANS
The Corporation's primary source of revenue and largest component of
earning assets is the loan portfolio. Due primarily to the acquisition of Rowan
Bank on August 1, 2002 as discussed in the "Overview", loans increased
$128,852,000 or 33.9% during the twelve-month period ended March 31, 2003. The
loan increase during the first quarter of 2003 was $7,116,000 or 1.4%. Average
loans were $124,669,000 or 32.5% higher in the first quarter of 2003 than in the
same period of 2002. The ratio of average loans to average deposits, in
comparing first quarter periods, increased from 78.7% in 2002 to 85.9% in 2003.
The ratio of loans to deposits at March 31, 2003 was 84.3%.
While the level of the entire loan portfolio has been adversely
affected for an extended period by the general slowdown in the economy, the
portfolios related to commercial and agricultural loans, construction loans and
commercial and other real estate loans experienced gains during the twelve-month
period ended March 31, 2003, exclusive of the initial impact of the Rowan Bank
acquisition on August 1, 2002. Commercial and agricultural loans also
experienced gains during the first quarter of 2003. The balance of the 1-4
family residential mortgage loan portfolio, exclusive of the initial impact of
the Rowan Bank acquisition, has been affected by the high level of refinancing
activity, especially since certain loans previously included in the "held for
investment" category were refinanced and subsequently sold.
18
ASSET QUALITY
Management considers the asset quality of the subsidiary banks to be of
primary importance. A formal loan review function, independent of loan
origination, is used to identify and monitor problem loans. As part of the loan
review function, a third party assessment group is employed to review the
underwriting documentation and risk grading analysis.
In determining the allowance for loan losses and any resulting
provision to be charged against earnings, particular emphasis is placed on the
results of the loan review process. Consideration is also given to a review of
individual loans, historical loan loss experience, the value and adequacy of
collateral, and economic conditions in the market areas of the subsidiary banks.
For loans determined to be impaired, the allowance is based on discounted cash
flows using the loan's initial effective interest rate or the fair value of the
collateral for certain collateral dependent loans. This evaluation is inherently
subjective as it requires material estimates, including the amounts and timing
of future cash flows expected to be received on impaired loans that may be
susceptible to significant change. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review the allowance
for loan losses of each of the subsidiary banks. Such agencies may require the
subsidiary banks to recognize changes to the allowance based on their judgments
about information available to them at the time of their examinations. Loans are
charged off when, in the opinion of management, they are deemed to be
uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance.
At March 31, 2003, the Corporation had impaired loans which totaled
$3,242,000, of which, loans totaling $3,180,000 were also on nonaccrual status.
The related allowance for loan losses on these loans amounted to $1,374,000. At
March 31, 2002, the Corporation had impaired loans which totaled $852,000 and
were also on nonaccrual status. The related allowance for loan losses on these
loans amounted to $450,000. At December 31, 2002, the Corporation had impaired
loans which totaled $3,211,000 and were also on nonaccrual status. The related
allowance for loan losses on these loans amounted to $1,401,000.
At March 31, 2003, nonperforming loans were $7,098,000 in total,
nonaccrual loans and accruing loans past due 90 days or more amounting to
$4,525,000 and $2,573,000, respectively. At March 31, 2002, nonperforming loans
were $4,423,000 in total, nonaccrual loans and accruing loans past due 90 days
or more amounting to $4,121,000 and $302,000, respectively. At December 31,
2002, nonperforming loans were $6,212,000 in total, nonaccrual loans and
accruing loans past due 90 days or more amounting to $4,944,000 and $1,268,000,
respectively.
A model that considers both allocated and unallocated components of the
allowance for loan losses is used on a quarterly basis to analyze the adequacy
of the allowance to absorb probable losses inherent in the loan portfolio.
Homogeneous pools of loans are segregated, and classifications of individual
loans within certain of these pools are identified using risk grades derived
from regulatory guidelines. Allocations of estimated reserves are assigned to
the most adversely classified loans based upon an individual analysis of
present-value repayment and/or liquidation projections of each loan. The reserve
is allocated to each pool, and remaining classifications within pools, based
upon a two-year historical loss ratio of First National Bank, concentrations
within industries, economic and industry-specific trends, portfolio trends, and
other subjective factors. An additional portion of the reserve is unallocated to
any specific portion of the loan portfolio, and is based upon the mix and weight
of the several homogeneous pools. The determination within the allowance model
of allocated and unallocated components is not necessarily indicative of future
losses or allocations. The entire balance of the allowance for loan losses is
available to absorb losses in the loan portfolio.
19
The allowance for loan losses, as a percentage of loans held for
investment, amounted to 1.22% at March 31, 2003, 1.21% at March 31, 2002 and
1.22% at December 31, 2002. The level of the allowance and the resulting
percentage relationship to loans held for investment has been influenced in
recent periods by asset quality considerations, increases in historical
charge-off trends and general economic conditions.
Management believes the allowance for loan losses of $6,169,000 at
March 31, 2003 is adequate to cover probable losses in the loan portfolio;
however, assessing the adequacy of the allowance is a process that requires
considerable judgment. Management's judgments are based on numerous assumptions
about current events which it believes to be reasonable, but which may or may
not be valid. Thus there can be no assurance that loan losses in future periods
will not exceed the current allowance or that future increases in the allowance
will not be required. No assurance can be given that management's ongoing
evaluation of the loan portfolio in light of changing economic conditions and
other relevant circumstances will not require significant future additions to
the allowance, thus adversely affecting the operating results of the
Corporation.
The following table presents an analysis of the changes in the
allowance for loan losses.
Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
(in thousands)
Balance at beginning of period $ 6,109 $ 4,417
Charge-offs 214 383
Recoveries 24 29
---------- ----------
Net loan charge-offs 190 354
Provision for loan losses 250 510
---------- ----------
Balance at end of period $ 6,169 $ 4,573
========== ==========
DEPOSITS
The level and mix of deposits is affected by various factors, including
general economic conditions, the particular circumstances of local markets and
the specific deposit strategies employed. In general, broad interest rate
declines tend to encourage customers to consider alternative investments such as
mutual funds and tax-deferred annuity products, while interest rate increases
tend to have the opposite effect.
In addition to the acquisition of Rowan Bank on August 1, 2002 as
discussed in the "Overview", the level and mix of deposits has been specifically
affected by the following factors. Money market deposits, excluding the amount
of Rowan Bank deposits initially added on August 1, 2002, had the most
significant growth of any component of deposits, increasing $22,039,000 during
the twelve-month period ended March 31, 2003 and $7,103,000 during the first
quarter of 2003. By similar comparison, interest-bearing demand deposits have
also grown significantly, increasing $11,777,000 during the twelve-month period
ended March 31, 2003, while declining $1,292,000 during the first quarter of
2003. Time deposits, reflecting the effect of interest rate declines, decreased
$30,437,000 during the twelve-month period ended March 31, 2003, although
registering a $598,000 increase during the first quarter of 2003. Further, the
level of time deposits obtained from governmental units fluctuates, amounting to
$43,688,000, $59,853,000 and $42,323,000 at March 31, 2003, March 31, 2002 and
December 31, 2002, respectively.
20
BUSINESS DEVELOPMENT MATTERS
As discussed in the "Overview" and in Note 3 to Consolidated Financial
Statements, the Corporation completed a merger on August 1, 2002 for the
acquisition of Rowan Bancorp, Inc., holding company for Rowan Savings Bank SSB,
Inc., headquartered in China Grove, North Carolina, in a transaction accounted
for using the purchase method of accounting for business combinations.
As also discussed in the "Overview" and in Note 3 to Consolidated
Financial Statements, on February 20, 2003, the Corporation entered into a
definitive merger agreement to acquire Dover Mortgage Company ("Dover"),
headquartered in Charlotte, North Carolina. Under the terms of the agreement,
Dover will be merged with a wholly-owned subsidiary of FNB Corp. formed for the
purposes of effecting the merger. Dover will then become a separate subsidiary
of FNB Corp. The merger is anticipated to close early in the second quarter of
2003.
In the 1998 fourth quarter, First National Bank received regulatory
approval for establishment of a new branch office in Trinity, North Carolina.
Construction of the permanent Trinity facility was completed in February 2002,
resulting in a total capital outlay of approximately $1,400,000. Prior to
completion of the permanent facility, a temporary mobile office, which opened in
August 1999, was operated at this site.
In April 2002, First National Bank received regulatory approval for
establishment of a new branch office in Pinehurst, North Carolina. The office,
located in a leased facility which had previously been used as a banking office
by another financial institution, was renovated and then opened for business in
October 2002.
ACCOUNTING PRONOUNCEMENT MATTERS
In June 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS No. 146"), 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)". SFAS No. 146 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 SFAS No. 144.
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 lease and (c) costs to consolidate facilities or relocate
employees. SFAS No. 146 does not apply to costs associated with the retirement
of a long-lived asset covered by SFAS 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 Corporation adopted the provisions of SFAS No. 146 with no
effect on its consolidated financial statements.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment of FASB Statement No. 123" ("SFAS No. 148"). SFAS No.
148 provides alternative methods of transition for an entity that voluntarily
changes to the fair value based method of accounting for stock-based employee
compensation. It
21
also requires prominent disclosure about the effects of reported net income of
an entity's accounting policy decisions with respect to stock-based employee
compensation. These provisions of SFAS No. 148 are effective for financial
statements for fiscal years ending after December 15, 2002. Finally, SFAS No.
148 amends APB Opinion No. 28, "Interim Financial Reporting", to require
disclosure about those effects in interim financial information. The Corporation
has adopted the disclosure provisions.
In November 2002, the FASB issued Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FASB
Interpretation No. 45"), which addresses the disclosure to be made by a
guarantor in its interim and annual financial statements about its obligations
under guarantees. FASB Interpretation No. 45 requires the guarantor to recognize
a liability for the non-contingent component of the guarantee, such as the
obligation to stand ready to perform in the event that specified triggering
events or conditions occur. The initial measurement of this liability is the
fair value of the guarantee at inception. The recognition of the liability is
required even if it is not probable that payments will be required under the
guarantee or if the guarantee was issued with a premium payment or as part of a
transaction with multiple elements. The disclosure requirements are effective
for interim and annual financial statements ending after December 15, 2002. The
initial recognition and measurement provisions are effective for all guarantees
within the scope of FASB Interpretation No. 45 issued or modified after December
31, 2002. The Corporation issues standby letters of credit whereby the
Corporation guarantees performance if a specified triggering event or condition
occurs. The guarantees generally expire within one year and may be automatically
renewed depending on the terms of the guarantee. Information concerning standby
letters of credit is presented in "Commitments, Contingencies and Off-Balance
Sheet Risk" and in Note 10 to the Consolidated Financial Statements.
In January 2003, the FASB issued Financial Accounting Standards Board
Interpretation No. 46, "Consolidation of Variable Interest Entities" (FASB
Interpretation No. 46"), which addresses consolidation by business enterprises
of variable interest entities. Under FASB Interpretation No. 46, an enterprise
that holds significant variable interest in a variable interest entity but is
not the primary beneficiary is required to disclose the nature, purpose, size
and activities of the variable interest entity, its exposure to loss as a result
of the variable interest holder's involvement with the entity, and the nature of
its involvement with the entity, and date when the involvement began. The
primary beneficiary of a variable interest entity is required to disclose the
nature, purpose, size and activities of the variable interest entity, the
carrying amount and classification of consolidated assets that are collateral
for the variable interest entity's obligations, and any lack of recourse by
creditors (or beneficial interest holders) of a consolidated variable interest
entity to the general creditors (or beneficial interest holders) of a
consolidated variable interest entity to the general credit of the primary
beneficiary. FASB Interpretation No. 46 is effective for the first fiscal year
or interim period beginning after June 15, 2003. The impact of adoption on the
Corporation is not known at this time.
CAUTIONARY STATEMENT FOR PURPOSE OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The statements contained in this Quarterly Report on Form 10-Q that are
not historical facts are forward-looking statements (as such term is defined in
the Private Securities Litigation Reform Act of 1995), which can be identified
by the use of forward-looking terminology such as "believes", "expects",
"plans", "projects", "goals", "estimates", "may", "could", "should", or
"anticipates" or the negative thereof or other variations thereon of comparable
terminology, or by discussions of strategy that involve risks and uncertainties.
In addition, from time to time, the Corporation or its representatives have made
or may make forward-looking statements, orally or in writing. Such
forward-looking statements may be included in, but are
22
not limited to, various filings made by the Corporation with the Securities and
Exchange Commission, or press releases or oral statements made by or with the
approval of an authorized executive officer of the Corporation. Forward-looking
statements are based on management's current views and assumptions and involve
risks and uncertainties that could significantly affect expected results. The
Corporation wishes to caution the reader that factors, such as those listed
below, in some cases have affected and could affect the Corporation's actual
results, causing actual results to differ materially from those in any
forward-looking statement. These factors include: (i) expected cost savings from
the Corporation's acquisitions described in the Overview may not materialize
within the expected time frame, (ii) revenues following the acquisitions may not
meet expectations, (iii) costs or difficulties related to the integration of the
businesses of the companies acquired may be greater than anticipated, (iv)
competitive pressure in the banking industry or in the Corporation's markets may
increase significantly, (v) changes in the interest rate environment may reduce
margins, (vi) general economic conditions, either nationally or regionally, may
be less favorable than expected, resulting in, among other things, credit
quality deterioration, (vii) changes may occur in banking legislation and in the
environment, (viii) changes may occur in general business conditions and
inflation and (ix) changes may occur in the securities markets. Readers should
also consider information on risks and uncertainties contained in the
discussions of competition, supervision and regulation, and effect of
governmental policies contained in the Corporation's most recent Annual Report
on Form 10-K.
23
TABLE 1
AVERAGE BALANCES AND NET INTEREST INCOME ANALYSIS
THREE MONTHS ENDED MARCH 31 2003 2002
------------------------------------ ------------------------------------
Average Average
Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/
Balance Expense Paid Balance Expense Paid
---------- ---------- ---------- ---------- ---------- ----------
(Taxable Equivalent Basis, Dollars in Thousands)
EARNING ASSETS
Loans (2) (3) $ 508,270 $ 8,202 6.52% $ 383,601 $ 6,796 7.16%
Investment securities (2):
Taxable income 122,426 1,692 5.53 139,960 2,376 6.79
Non-taxable income 28,662 522 7.29 24,993 465 7.44
Other earning assets 35,158 105 1.21 7,110 29 1.66
---------- ---------- ---------- ---------- ---------- ----------
Total earning assets 694,516 10,521 6.10 555,664 9,666 7.01
---------- ---------- ---------- ---------- ---------- ----------
Cash and due from banks 15,485 11,859
Goodwill 12,601 -
Other assets, net 31,817 27,061
---------- ----------
Total Assets $ 754,419 $ 594,584
========== ==========
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Demand deposits $ 81,289 122 0.61 $ 59,942 97 0.66
Savings deposits 50,365 85 0.68 34,585 85 1.00
Money market deposits 73,539 264 1.46 50,205 243 1.96
Certificates and other time deposits 328,026 2,222 2.75 291,044 2,683 3.74
Retail repurchase agreements 17,959 54 1.23 13,617 62 1.83
Federal Home Loan Bank advances 53,380 576 4.37 30,000 361 4.88
Federal funds purchased 53 - 1.61 638 3 2.03
Other borrowed funds 11,000 98 3.61 - - -
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities 615,611 3,421 2.25 480,031 3,534 2.99
---------- ---------- ---------- ---------- ---------- ----------
Noninterest-bearing demand deposits 58,621 51,600
Other liabilities 6,214 6,024
Shareholders' equity 73,973 56,929
---------- ----------
Total Liabilities and
Shareholders' Equity $ 754,419 $ 594,584
========== ==========
Net Interest Income and Spread $ 7,100 3.85% $ 6,132 4.02%
========== ========== ========== ==========
Net Yield on Earning Assets 4.11% 4.43%
========== ==========
THREE MONTHS ENDED MARCH 31
2003 Versus 2002
------------------------------------
Interest Variance
due to (1)
----------------------- Net
Volume Rate Change
---------- ---------- ----------
(Taxable Equivalent Basis, Dollars
in Thousands)
EARNING ASSETS
Loans (2) (3) $ 2,052 $ (646) $ 1,406
Investment securities (2):
Taxable income (276) (408) (684)
Non-taxable income 67 (10) 57
Other earning assets 86 (10) 76
---------- ---------- ----------
Total earning assets 1,929 (1,074) 855
---------- ---------- ----------
Cash and due from banks
Goodwill
Other assets, net
Total Assets
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Demand deposits 33 (8) 25
Savings deposits 32 (32) -
Money market deposits 93 (72) 21
Certificates and other time deposits 311 (772) (461)
Retail repurchase agreements 16 (24) (8)
Federal Home Loan Bank advances 256 (41) 215
Federal funds purchased (2) (1) (3)
Other borrowed funds 98 - 98
---------- ---------- ----------
Total interest-bearing liabilities 837 (950) (113)
---------- ---------- ----------
Noninterest-bearing demand deposits
Other liabilities
Shareholders' equity
Total Liabilities and
Shareholders' Equity
Net Interest Income and Spread $ 1,092 $ (124) $ 968
========== ========== ==========
Net Yield on Earning Assets
(1) The mix variance, not separately stated, has been proportionally allocated
to the volume and rate variances based on their absolute dollar amount.
(2) Interest income and yields related to certain investment securities and
loans exempt from both federal and state income tax or from state income
tax alone are stated on a fully taxable equivalent basis, assuming a 34%
federal tax rate and applicable state tax rate, reduced by the
nondeductible portion of interest expense.
(3) Nonaccrual loans are included in the average loan balance. Loan fees and
the incremental direct costs associated with making loans are deferred and
subsequently recognized over the life of the loan as an adjustment of
interest income.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse
changes in market price and interest rates. This risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods.
The Corporation's market risk arises primarily from interest rate risk
inherent in its lending and deposit-taking activities. The structure of the
Corporation's loan and deposit portfolios is such that a significant decline in
interest rates may adversely impact net market values and net interest income.
The Corporation does not maintain a trading account nor is the Corporation
subject to currency exchange risk or commodity price risk. Interest rate risk is
monitored as part of the Corporation's asset/liability management function,
which is discussed above in Item 2 "Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the heading
"Asset/Liability Management and Interest Rate Sensitivity".
Management does not believe there has been any significant change in
the overall analysis of financial instruments considered market risk sensitive,
as measured by the factors of contractual maturities, average interest rates and
estimated fair values, since the analysis prepared and presented in conjunction
with the Form 10-K Annual Report for the fiscal year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation of the Corporation's disclosure controls and
procedures, which was completed within 90 days prior to the filing of this
report, the Chief Executive Officer and the Chief Financial Officer of the
Corporation have concluded that the Corporation's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Corporation in the reports that it files or submits under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. In reaching this conclusion, the Corporation's
Chief Executive Officer and Chief Financial Officer determined that the
Corporation's disclosure controls and procedures are effective in ensuring that
such information is accumulated and communicated to the Corporation's management
to allow timely decisions regarding required disclosure.
There were no significant changes in the Corporation's internal
controls or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
25
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibits to this report are listed in the index to exhibits on
pages 29 and 30 of this report.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended March
31, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
FNB Corp.
(Registrant)
Date: May 12, 2003 By: /s/ Jerry A. Little
-----------------------------
Jerry A. Little
Treasurer and Secretary
(Principal Financial and
Accounting Officer)
26
CERTIFICATIONS
I, Michael C. Miller, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FNB Corp.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and 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
quarterly 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 quarterly report (the "Evaluation Date");
and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly 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: May 12, 2003 /s/ Michael C. Miller
---------------------------------
Michael C. Miller
Chief Executive Officer
27
I, Jerry A. Little, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FNB Corp.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and 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
quarterly 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 quarterly report (the "Evaluation Date");
and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly 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: May 12, 2003 /s/ Jerry A. Little
---------------------------------
Jerry A. Little
Chief Financial Officer
28
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ---------- ----------------------
2.10 Agreement and Plan of Merger dated as of February 11,
2002 by and between the Registrant and Rowan Bancorp,
Inc., incorporated herein by reference to Exhibit 2.10
to the Registrant's Form 10-K Annual Report for the
fiscal year ended December 31, 2001.
2.11 Merger Agreement dated as of February 20, 2003 by and
among the Registrant, Dover Mortgage Company and the
shareholders of Dover Mortgage Company, incorporated
herein by reference to Exhibit 2.11 to the Registrant's
Form 10-K Annual Report for the fiscal year ended
December 31, 2002.
3.10 Articles of Incorporation of the Registrant,
incorporated herein by reference to Exhibit 3.1 to the
Registrant's Form S-14 Registration Statement (No.
2-96498) filed June 16, 1985.
3.11 Articles of Amendment to Articles of Incorporation of
the Registrant, adopted May 10, 1988, incorporated
herein by reference to Exhibit 19.10 to the
Registrant's Form 10-Q Quarterly Report for the quarter
ended June 30, 1988.
3.12 Articles of Amendment to Articles of Incorporation of
the Registrant, adopted May 12, 1998, incorporated
herein by reference to Exhibit 3.12 to the Registrant's
Form 10-Q Quarterly Report for the quarter ended June
30, 1998.
3.20 Amended and Restated Bylaws of the Registrant, adopted
May 21, 1998, incorporated herein by reference to
Exhibit 3.20 to the Registrant's Form 10-Q Quarterly
Report for the quarter ended June 30, 1998.
4 Specimen of Registrant's Common Stock Certificate,
incorporated herein by reference to Exhibit 4 to
Amendment No. 1 to the Registrant's Form S-14
Registration Statement (No. 2-96498) filed April 19,
1985.
10.10* Form of Split Dollar Insurance Agreement dated as of
November 1, 1987 between First National Bank and Trust
Company and certain of its key employees and directors,
incorporated herein by reference to Exhibit 19.20 to
the Registrant's Form 10-Q Quarterly Report for the
quarter ended June 30, 1988.
10.11* Form of Amendment to Split Dollar Insurance Agreement
dated as of November 1, 1994 between First National
Bank and Trust Company and certain of its key employees
and directors, incorporated herein by reference to
Exhibit 10.11 to the Registrant's Form 10-KSB Annual
Report for the fiscal year ended December 31, 1994.
29
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ---------- ----------------------
10.20* Stock Compensation Plan as amended effective May 12,
1998, incorporated herein by reference to Exhibit 10.30
the Registrant's Form 10-Q Quarterly Report for the
quarter ended June 30, 1998.
10.21* Form of Incentive Stock Option Agreement between FNB
Corp. and certain of its key employees, pursuant to the
Registrant's Stock Compensation Plan, incorporated
herein by reference to Exhibit 10.31 to the
Registrant's Form 10-KSB Annual Report for the fiscal
year ended December 31, 1994.
10.22* Form of Nonqualified Stock Option Agreement between FNB
Corp. and certain of its directors, pursuant to the
Registrant's Stock Compensation Plan, incorporated
herein by reference to Exhibit 10.32 to the
Registrant's Form 10-KSB Annual Report for the fiscal
year ended December 31, 1994.
10.30* Employment Agreement dated as of December 27, 1995
between First National Bank and Trust Company and
Michael C. Miller, incorporated herein by reference to
Exhibit 10.50 to the Registrant's Form 10-KSB Annual
Report for the fiscal year ended December 31, 1995.
10.31* Carolina Fincorp, Inc. Stock Option Plan (assumed by
the Registrant on April 10, 2000), incorporated herein
by reference to Exhibit 99.1 to the Registrant's
Registration Statement on Form S-8 (File No.
333-54702).
10.32* Employment Agreement dated as of April 10, 2000 between
First National Bank and Trust Company and R. Larry
Campbell, incorporated herein by reference to Exhibit
10.32 to the Registrant's Form 10-K Annual Report for
the fiscal year ended December 31, 2000.
10.33* Nonqualified Supplemental Retirement Plan with R. Larry
Campbell, incorporated herein by reference to Exhibit
10(c) to the Annual Report on Form 10-KSB of Carolina
Fincorp, Inc. for the fiscal year ended June 30, 1997.
10.34* Employment Agreement dated as of August 1, 2002 between
Rowan Savings Bank SSB, Inc. and Bruce D. Jones,
incorporated herein by reference to the Registrant's
Form 10-Q Quarterly Report for the quarter ended
September 30, 2002.
99 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
- ----------
* Management contract, or compensatory plan or arrangement.
30