UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to __________
Commission file number 000-09424
FIRST M&F CORPORATION
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(Exact Name of Registrant as specified in its Charter)
MISSISSIPPI 64-0636653
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(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
134 West Washington Street, Kosciusko, Mississippi 39090
- --------------------------------------------------------------- --------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number: 662-289-5121
------------------------------------------
Securities registered under Section 12(b) of the Act:
None None
- ----------------------------------------------------------------- --------------------------------------------------
(Title of Each Class) (Name of Each Exchange on Which Registered)
Securities registered pursuant to section 12(g) of the Act:
Common Stock, $5 par value None
- ----------------------------------------------------------------- --------------------------------------------------
(Title of Each Class) (Name of Each Exchange on Which Registered)
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 periods that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 2b-2 of the Act).
YES [X] NO [ ]
Based on closing sale price for shares on December 31, 2003, the aggregate market value of the voting stock held by
nonaffiliates of the Registrant was $127,839,391.
Based on closing sale price for shares on June 30, 2003, the aggregate market value of the voting stock held by
nonaffiliates of the Registrant was $111,851,747.
Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest
practicable date.
Class Outstanding at January 31, 2002
----- -------------------------------
Common stock ($5.00 par value) 4,574,169 Shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference into Parts III of the Form 10-K report:
Proxy Statement dated March 9, 2004.
II-1
CROSS REFERENCE INDEX
PART I Page
Item 1 Business II-3
Item 2 Properties II-10
Item 3 Legal Proceedings II-10
Item 4 Submission of Matters to a Vote of Security Holders II-10
PART II
Item 5 Market for Registrant's Common Stock and Related Stockholder Matters II-10
Item 6 Selected Financial Data II-11
Item 7 Management's Discussion and Analysis of Financial Condition and Results II-16
of Operations
Item 7A Quantitative and Qualitative Disclosures About Market Risk II-23
Item 8 Financial Statements and Supplemental Data II-25
Item 9 Changes In and Disagreements with Accountants on Accounting and II-63
Financial Disclosure
Item 9A Controls and Procedures II-63
PART III
Item 10 Directors and Executive Officers of the Registrant II-63
Item 11 Executive Compensation II-63
Item 12 Security Ownership of Certain Beneficial Owners and Management II-63
Item 13 Certain Relationships and Related Transactions II-64
Item 14 Principal Accounting Fees and Services II-64
PART IV
Item 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K II-64
- ----------------
*Information called for by Part III (Items 10 through 14) is incorporated by reference to the Registrant's Proxy
Statement dated March 9, 2004.
II-2
PART I
BUSINESS
General
First M & F Corporation (the Company) is a one-bank holding company chartered and organized under Mississippi laws in 1979. The Company engages exclusively in the banking business through its wholly-owned subsidiary, M & F Bank of Kosciusko (the Bank).
The Bank was chartered and organized under the laws of the State of Mississippi in 1890, and accounts for substantially all of the total assets and revenues of the Company. The Bank is the sixth largest bank in the state, having total assets of approximately $1.075 billion at December 31, 2003. The Bank offers a complete range of commercial and consumer services at its main office and two branches in Kosciusko and its branches within central Mississippi, including Ackerman, Bruce, Brandon, Canton, Cleveland, Clinton, Durant, Grenada, Lena, Madison, Olive Branch, Oxford, Pearl, Philadelphia, Ridgeland, Southaven, Starkville, Tupelo, and Weir, Mississippi.
The Bank has six wholly-owned subsidiaries, M & F Financial Services, Inc., which is currently inactive, First M & F Insurance Company, Inc., a credit life insurance company, M & F Insurance Agency, Inc., a general insurance agency, M & F Insurance Group, Inc., a general insurance agency, M & F Bank Securities Corporation, a real estate property management company, and M & F Business Credit, Inc., an asset-based lending operation. The Bank owns 51% of a joint venture, Merchants Financial Services, 49% of which is owned by an unaffiliated company. The joint venture engages in small business accounts receivable factoring, and is consolidated into the Company's financial statements for reporting purposes.
The banking system offers a variety of deposit, investment and credit products to customers. The Bank provides these services to middle market and professional businesses, ranging from payroll checking, business checking, corporate savings and secured and unsecured lines of credit. Additional services include direct deposit payroll, sweep accounts and letters of credit. The Bank also offers credit card services to its customers, to include check debit cards and automated teller machine cards through several networks. Trust services are also offered in the Kosciusko main office.
As of December 31, 2003, the Company and its subsidiary employed 436 full-time equivalent employees.
CompetitionThe Company competes generally with other banking institutions, savings associations, credit unions, mortgage banking firms, consumer finance companies, mutual funds, insurance companies, securities brokerage firms, and other finance related institutions; many of which have greater resources than those available to the Company. The competition is primarily related to interest rates, the availability and quality of services and products, and the pricing of those services and products.
Supervision and RegulationAs a bank holding company, First M & F Corporation is subject to regulation under the Bank Holding Company Act of 1956, as amended, (the "BHCA") and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). Under the BHCA, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. The BHCA also generally limits the activities of a bank holding company to that of banking, managing or controlling banks, or any other activity which is determined to be so closely related to banking or managing or controlling banks that an exception is allowed for those activities.
As a state-chartered commercial bank, M & F Bank, First M & F Corporation's banking subsidiary, is subject to regulation, supervision and examination by the Mississippi Department of Banking and Consumer Finance. M & F Bank (the "Bank") is also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the "FDIC"). State and Federal law also govern the activities in which the Bank engages, the investments it makes and the aggregate amount of loans that may be granted to one borrower. The insurance company subsidiary of the Bank is also regulated and examined by the Insurance Department of the State of Mississippi.
The earnings of the Bank and its subsidiaries are affected by general economic conditions, management policies, changes in state and Federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes the significant state and Federal laws to which the Company, the Bank and subsidiaries are subject.
II-3The Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve Board and the FDIC. There are two basic measures of capital adequacy for bank holding companies and their banking subsidiaries; a risk-based measure and a leverage measure.
The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among depository institutions and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
The minimum guideline for the total capital to risk-weighted assets, including certain off-balance sheet items such as standby letters of credit ("total capital ratio") is 8.0 percent. At least half of total capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets ("Tier 1 capital"). The remainder may consist of subordinated debt, other preferred stock, a limited amount of loan loss allowances, and unrealized gains on equity securities subject to limitations ("Tier 2 capital"). At December 31, 2003, the Company and the Bank were in compliance with the total capital ratio and the Tier 1 capital ratio requirements. Note 17 of the Notes to Consolidated Financial Statements presents the Company's and the Bank's capital ratios.
Deposit Insurance AssessmentsThe deposits of the Bank are insured by the FDIC up to the limits set forth under applicable law. A majority of the deposits of the Bank are subject to the deposit insurance assessments of the Bank Insurance Fund ("BIF") of the FDIC. However, a portion of the Bank's deposits, relating to a savings association acquisition, are subject to assessments imposed by the Savings Association Insurance Fund ("SAIF") of the FDIC. The FDIC equalized the assessment rates for BIF-insured and SAIF-insured deposits effective January 1, 1997. The assessments imposed on all FDIC deposits for deposit insurance have an effective rate ranging from 0 to 27 basis points per $100 of insured deposits, depending on the institution's capital position and other supervisory factors. Legislation was enacted in 1996 requiring both SAIF-insured and BIF-insured deposits to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation ("FICO"). The FDIC is currently assessing, effective for the first quarter of 2004, BIF- and SAIF-insured deposits totaling an additional 1.54 basis points per $100 of deposits.
Available InformationThe Company maintains an Internet website at www.mfbank.com. The Company makes available free of charge on the website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed with the Securities and Exchange Commission. These reports are made available on the Company's website as soon as reasonably practical after the reports are filed with the Commission. Information on the Company's website is not incorporated into this Form 10-K or the Company's other securities filings and is not a part of them.
II-4
STATISTICAL DISCLOSURE
The statistical disclosures for the Company are contained in Tables 1 through 12.
Table 1
AVERAGE BALANCE SHEETS/YIELDS
2003 2002 2001
-------------------------------- ------------------------------- ----------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
----------- ----------- ------- ----------- -------- ------ -------- -------- -------
Interest bearing bank balances 7,451 108 1.45% 7,387 124 1.68% 9,032 417 4.62%
Federal funds sold 16,690 192 1.15% 10,241 163 1.59% 16,173 683 4.22%
Taxable investments 152,408 6,653 4.37% 194,120 9,998 5.15% 190,236 11,418 5.99%
Tax-exempt investments 54,980 3,793 6.90% 56,567 4,104 7.26% 59,441 4,454 7.49%
Loans 730,133 48,685 6.67% 660,529 49,125 7.44% 645,541 55,151 8.54%
-------------------------------------------------------------------------------------------------
Total earning assets 961,662 59,431 6.18% 928,844 63,514 6.84% 920,423 72,123 7.83%
Nonearning assets 100,275 94,202 89,699
--------- --------- ---------
Total average assets 1,061,937 1,023,046 1,010,122
NOW, MMDA & Savings 382,028 4,221 1.10% 361,213 5,986 1.66% 291,891 8,443 2.89%
Certificates of deposit 345,848 9,178 2.65% 355,745 13,813 3.88% 415,846 23,341 5.61%
Short-term borrowings 18,757 608 3.24% 20,512 695 3.39% 17,301 756 4.37%
Other borrowings 87,579 3,850 4.40% 72,010 3,208 4.45% 83,725 4,815 5.75%
-------------------------------------------------------------------------------------------------
Total interest bearing liabilities 834,212 17,857 2.14% 809,480 23,702 2.93% 808,763 37,355 4.62%
Noninterest bearing deposits 107,493 99,672 92,928
Noninterest bearing liabilities 9,324 8,940 8,234
Capital 110,908 104,954 100,197
--------- -------- --------
Total average liabilities and 1,061,937 1,023,046 1,010,122
equity ------- ------- -------
Net interest margin 41,574 4.32% 39,812 4.29% 34,768 3.78%
Less tax equivalent adjustment
Investments 1,415 1,531 1,661
Loans 98 110 142
------- ------- -------
Reported book net interest margin 40,061 4.17% 38,171 4.11% 32,965 3.58%
Tax equivalent adjustments were made using a blended Federal/State rate of 37.3%.
Table 2
RATE/VOLUME VARIANCES
2003 Compared To 2002 2002 Compared To 2001
Increase (Decrease) Due To Increase (Decrease) Due To
--------------------------------- ---------------------------------
Yield Yield/
Volume Cost Net Volume Cost Net
--------------------------------- ---------------------------------
Interest earned on:
Interest bearing bank balances 1 (17) (16) (52) (241) (293)
Federal funds sold 88 (59) 29 (172) (348) (520)
Taxable investments (1,985) (1,360) (3,345) 214 (1,634) (1,420)
Tax-exempt investments (112) (199) (311) (212) (138) (350)
Loans 4,909 (5,349) (440) 1,198 (7,224) (6,026)
--------------------------------- ---------------------------------
Total earning assets 2,136 (6,219) (4,083) 976 (9,585) (8,609)
Interest paid on:
NOW, MMDA & Savings 287 (2,052) (1,765) 1,577 (4,034) (2,457)
Certificates of deposit (323) (4,312) (4,635) (2,854) (6,674) (9,528)
Short-term borrowings (58) (29) (87) 125 (186) (61)
Other borrowings 689 (47) 642 (598) (1,009) (1,607)
--------------------------------- ---------------------------------
Total interest bearing liabilities 627 (6,472) (5,845) 27 (13,680) (13,653)
Change in net interest income 1,509 253 1,762 949 4,095 5,044
on a tax-equivalent basis
The rate/volume variances are computed for each line item and are therefore non-additive.
II-5
Table 3
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SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY
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Carrying Value of Securities
December 31
2003 2002 2001
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Securities Available For Sale
U. S. Treasury 560 1,082 3,056
Government agencies 69,794 60,806 24,908
Mortgage-backed securities 51,526 107,868 150,618
Obligations of states and political subdivisions 60,071 59,642 65,108
Other securities 5,626 6,712 6,668
------------------------------------------
Total securities available for sale 187,577 236,110 250,358
Book Value of Securities
December 31
2003 2002 2001
------------------------------------------
Securities Available For Sale
U. S. Treasury 532 1,037 3,045
Government agencies 67,954 58,125 24,486
Mortgage-backed securities 49,986 104,122 149,037
Obligations of states and political subdivisions 57,503 56,954 64,352
Other securities 5,400 6,379 6,462
------------------------------------------
Total securities available for sale 181,375 226,617 247,382
Table 4
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MATURITY DISTRIBUTION AND YIELDS OF SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY
- ---------------------------------------------------------------------------------------------------------------------------
After One
Within But Within After Five
One Five But Within Over
Year Yield Years Yield Ten Years Yield Ten Years Yield Total Yield
- ---------------------------------------------------------------------------------------------------------------------------
Securities Available For Sale
U.S. Treasury 0 0.00% 0 0.00% 532 4.60% 0 0.00% 532 4.60%
Government agencies 14,677 4.05% 52,765 3.80% 512 5.38% 0 0.00% 67,954 3.87%
Mortgage-backed securities 28,573 5.28% 17,070 4.80% 2,929 4.54% 1,414 4.83% 49,986 5.06%
Obligations of states and
political subdivisions 8,832 7.43% 40,026 6.89% 8,413 5.99% 232 6.08% 57,503 6.84%
Other debt securities 1,301 4.70% 2,063 6.53% 0 0.00% 1,000 2.87% 4,364 5.15%
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Total securities available 53,383 5.29% 111,924 5.11% 12,386 5.56% 2,646 4.20% 180,339 5.18%
for sale
Equity securities 1,036
-------
181,375
Tax equivalent adjustments were made using a blended Federal rate of 34.0% and a State rate of 5.0%. The amounts
shown represent the investment portfolio as stated at amortized cost.
Non mortgage backed securities are categorized in the earlier of their maturity dates or their call dates.
Mortgage baced securities are distributed based upon their estimated average lives.
II-6
Table 5
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COMPOSITION OF THE LOAN PORTFOLIO
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2003 2002 2001 2000 1999
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% Of % Of % Of % Of % Of
Amount Total Amount Total Amount Total Amount Total Amount Total
---------------------------------------------------------------------------------------
Commercial, financial
and agricultural 112,443 14.39% 94,169 13.87% 86,040 13.01 75,942 12.01% 68,521 11.25%
Non-residential real estate 339,547 43.46% 262,141 38.62% 234,950 35.53% 202,619 32.04% 172,982 28.41%
Residential real estate 265,591 33.99% 244,032 35.95% 247,384 37.41% 249,745 39.50% 250,875 41.20%
Consumer loans 63,740 8.16% 78,395 11.55% 92,875 14.04% 103,960 16.44% 116,543 19.14%
Lease financing 0 0.00% 9 0.00% 33 0.00% 51 0.01% 29 0.00%
---------------------------------------------------------------------------------------
Total loans 781,321 100.00% 678,746 100.00% 661,282 100.00% 632,317 100.00% 608,950 100.00%
Table 6
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LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES
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Maturity distribution of loans at December 31, 2003
- --------------------------------------------------------------------------------------------------------------------
Within One to Five After Five
One Year Years Years Total
------------------------------------------------------------
Commercial, financial and agricultural 72,866 37,082 2,495 112,443
Non-residential real estate 114,948 205,389 19,210 339,547
Residential real estate 52,592 181,976 31,023 265,591
Consumer loans 37,590 26,044 106 63,740
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Total loans 277,996 450,491 52,834 781,321
Rate sensitivity of loans at December 31, 2003
One to Five After Five
Years Years Total
----------------------------------------------
Fixed rate loans 380,896 30,188 411,084
Floating rate loans 69,595 22,646 92,241
----------------------------------------------
450,491 52,834 503,325
Table 7
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NONPERFORMING ASSETS AND PAST DUE LOANS
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2003 2002 2001 2000 1999
-----------------------------------------------------
Nonaccrual loans 4,517 1,582 1,825 1,385 2,072
Restructured loans 0 0 0 0 0
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Total nonperforming loans 4,517 1,582 1,825 1,385 2,072
Other real estate owned 802 950 1,077 965 1,150
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Total nonperforming assets 5,319 2,532 2,902 2,350 3,222
Accruing loans past due 90 days or more 1,531 2,169 1,958 1,906 1,069
-----------------------------------------------------
Total nonperforming assets and loans 6,850 4,701 4,860 4,256 4,291
Table 8
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ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------------------------------------------------
Balance at beginning of year 10,258 8,426 8,510 7,629 5,835
Adjustment for purchase acquisition 0 0 0 0 866
Charge offs
Commercial, financial and agricultural (721) (650) (2,313) (1,897) (134)
Real estate - nonresidential (318) (332) (301) (176) (58)
Real estate - residential (1,120) (474) (507) (164) (289)
Consumer (1,516) (1,849) (2,167) (1,989) (1,612)
--------------------------------------------------
Total (3,675) (3,305) (5,288) (4,226) (2,093)
Recoveries
Commercial, financial and agricultural 85 82 74 70 46
Real estate - nonresidential 56 37 20 37 50
Real estate - residential 27 6 50 46 1
Consumer 338 517 645 655 540
--------------------------------------------------
Total 506 642 789 808 637
--------------------------------------------------
Net charge offs (3,169) (2,663) (4,499) (3,418) (1,456)
Provision for loan losses 3,802 4,495 4,415 4,299 2,384
--------------------------------------------------
Balance at end of year 10,891 10,258 8,426 8,510 7,629
Net Charge Offs To Average Loans 0.43% 0.40% 0.69% 0.54% 0.32%
Table 9
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ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
- --------------------------------------------------------------------------------------------
December 31
2003 2002 2001 2000 1999
--------------------------------------------------
Commercial, financial and agricultural 4,833 3,804 2,380 1,291 1,672
Non-residential real estate 317 322 411 487 383
Residential real estate 330 1,048 1,102 1,596 1,313
Consumer loans 5,411 5,084 4,533 5,136 4,261
--------------------------------------------------
Total loans 10,891 10,258 8,426 8,510 7,629
Allowance As A Percentage Of Loan Type
December 31
2003 2002 2001 2000 1999
--------------------------------------------------
Commercial, financial and agricultural 4.30% 4.04% 2.77% 1.70% 2.44%
Non-residential real estate 0.09% 0.12% 0.18% 0.24% 0.22%
Residential real estate 0.12% 0.43% 0.45% 0.64% 0.52%
Consumer loans 8.49% 6.48% 4.88% 4.94% 3.66%
--------------------------------------------------
Total loans 1.39% 1.51% 1.27% 1.35% 1.25%
Net Charge Offs As A Percent Of Year End Loans Outstanding, By Type
December 31
2003 2002 2001 2000 1999
--------------------------------------------------
Commercial, financial and agricultural 0.57% 0.60% 2.60% 2.41% 0.13%
Non-residential real estate 0.08% 0.11% 0.12% 0.07% 0.00%
Residential real estate 0.41% 0.19% 0.18% 0.05% 0.11%
Consumer loans 1.85% 1.70% 1.64% 1.28% 0.92%
--------------------------------------------------
Total loans 0.41% 0.39% 0.68% 0.54% 0.24%
II-8
Table 10
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TIME DEPOSITS OF $100,000 OR MORE
- --------------------------------------------------------------------------------------------
The table below shows maturities of outstanding time deposits of $100,000 or more at December 31, 2003 (in thousands):
Three months or less $35,635
Over three months through six months 35,772
Over six months through twelve months 22,836
Over one year 51,526
--------
Total 145,769
Table 11
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SELECTED RATIOS
- --------------------------------------------------------------------------------------------
The following table reflects ratios for the Company for the last three years:
2003 2002 2001
------------------------------------------
Return on average assets 1.03% 1.00% 0.71%
Return on average equity 9.82% 9.75% 7.14%
Dividend payout ratio 42.37% 45.05% 64.52%
Average equity to assets ratio 10.44% 10.26% 9.92%
Table 12
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SHORT-TERM BORROWINGS
- --------------------------------------------------------------------------------------------
The table below presents certain information regarding the Company's short-term borrowings for each of the last
three years (in thousands of dollars):
2003 2002 2001
-------------------------------
Outstanding at end of period 15,205 23,599 16,458
Maximum outstanding at any 31,459 23,599 20,562
month-end during the period
Average outstanding during the period 18,757 20,513 17,301
Interest paid 608 695 756
Weighted average rate during 3.24% 3.39% 4.37%
each period
II-9
The Bank's legal headquarters is a 21,000 square foot, three story, brick building located at 134 West Washington Street. The building has a banking office and drive-up facility occupying the first floor. This building houses the primary administrative offices of the Bank and Company.
The Bank owns its main office building and 30 of its branch facilities. The remaining facilities are occupied under lease agreements, the terms of which range from month to month to five years. It is anticipated that all leases will be renewed.
There has been a trend toward increased litigation against financial services companies arising out of consumer lending and other consumer financial transactions, especially in Mississippi. Some of these actions have resulted in large settlements or substantial damage awards. The Bank and one of its subsidiaries are subject to similar cases that seek substantial damages for claims arising out of transactions that involve relatively small amounts of money. While the allegations vary from case to case, in general they allege that loans were originated or renewed in a way that the borrowers were improperly sold insurance products, such as credit life insurance. The Company has denied these allegations and will vigorously defend the claims.
In total, there are cases involving approximately 300 plantiffs that have been filed over a three year period. Some suits have been filed in Homes County. Depositions have occurred in one suit, and a trial date has been tentatively set for October, 2004 in another suit. It is not possible at this time to determine the potential exposure related to possible damages in connection with these suits. Future legislation and court decisions may limit the amount of damages that can be recovered in legal proceedings such as these. However, management cannot predict at this time whether such legislation or court decisions will occur or the effect they may have on these cases.
The Bank's insurance agency subsidiary is involved in a suit filed in Holmes County in 2003 alleging unfair pricing of insurance products by an insurance underwriting company whose products the agency sells. It is not possible at this time for management to determine the potential exposure related to possible damages involved in this suit. No action has occurred in the suit.
Additionally, the Company and its subsidiaries are defendants in various other lawsuits arising out of the normal course of business. In the opinion of management, the ultimate resolution of this category of claims should not have a material adverse effect on the Company's consolidated financial position or results of operations.
No matters were submitted to a shareholder vote during the fourth quarter of 2003.
Effective September 1, 1996, the Company's common stock was listed with the National Association of Securities Dealers, Inc. Automated Quotation National Market System (NASDAQ) and became subject to trading and reporting over the counter with most securities dealers.
At December 31, 2003, there were 1,273 shareholders of record of the Company's common stock. On December 31, 2003, the Company's stock closed at $37.90 per share.
II-10
SELECTED FINANCIAL DATA
First M & F Corporation
And Subsidiary
(Thousands, except per share data) 2003 2002 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------------------------
EARNINGS
Interest income $57,918 $61,873 $70,320 $73,354 $53,677
Interest expense 17,857 23,702 37,355 41,227 25,210
------------------------------------------------------------------------
Net interest income 40,061 38,171 32,965 32,127 28,467
Provision for loan losses 3,802 4,495 4,415 4,299 2,384
Noninterest income 14,357 14,088 13,783 10,576 8,431
Noninterest expense 35,121 33,394 32,118 29,803 23,343
Income taxes 4,603 4,135 3,062 1,522 3,005
------------------------------------------------------------------------
Net income $10,892 $10,235 $7,153 $7,079 $8,166
------------------------------------------------------------------------
Net interest income, taxable equivalent $41,574 $39,811 $34,768 $33,981 $30,675
------------------------------------------------------------------------
Cash dividends paid $4,604 $4,610 $4,615 $4,626 $3,920
------------------------------------------------------------------------
PER COMMON SHARE
Net income (basic) $2.36 $2.22 $1.55 $1.53 $2.16
Cash dividends paid 1.00 1.00 1.00 1.00 1.00
Book value 24.24 23.59 21.68 21.01 19.41
Closing stock price 37.90 27.75 20.50 16.88 30.00
SELECTED AVERAGE BALANCES
Assets $1,061,937 $1,023,046 $1,010,122 $1,009,619 $759,584
Earning assets 973,764 937,991 933,061 928,792 697,667
Loans 734,240 663,503 648,444 631,295 457,023
Investments 215,382 256,861 259,412 280,135 230,268
Total deposits 835,369 816,630 800,665 791,797 655,647
Equity 110,908 104,954 100,197 91,986 67,003
SELECTED YEAR-END BALANCES
Assets $1,078,298 $1,037,134 $1,018,309 $1,020,416 $1,023,037
Earning assets 972,402 935,166 917,892 926,900 925,995
Loans 781,321 678,746 661,282 633,209 608,950
Investments 187,577 236,110 250,921 264,634 292,179
Total deposits 820,226 824,024 816,617 787,554 789,941
Equity 110,678 108,210 100,063 96,942 90,677
SELECTED RATIOS
Return on average assets 1.03% 1.00% .71% .70% 1.08%
Return on average equity 9.82% 9.75% 7.14% 7.70% 12.19
Average equity to average assets 10.44% 10.26% 9.92% 9.11% 8.82
Dividend payout ratio 42.37% 45.05% 64.52% 65.36% 46.30
Price to earnings (x) 16.06x 12.50x 13.23x 11.03x 13.89x
Price to book (x) 1.56x 1.18x .95x .80x 1.55x
II-11
FINANCIAL HIGHLIGHTS
First M & F Corporation
And Subsidiary
Five-Year
Compounded
Percent Growth
(Dollars in Thousands, except per share) 2003 2002 Change Rate
- -----------------------------------------------------------------------------------------------------------------------
EARNINGS
Net interest income $40,061 $38,171 4.95 % 10.07
Noninterest income 14,357 14,088 1.91 17.82
Noninterest expense 35,121 33,394 5.17 13.41
Net income 10,892 10,235 6.42 6.79
AVERAGE BALANCES
Assets $1,061,937 $1,023,046 3.80 % 9.58
Earning assets 973,764 937,991 3.81 9.40
Loans 734,240 663,503 10.66 13.26
Deposits 835,369 816,630 2.29 6.97
Shareholders' equity 110,908 104,954 5.67 12.83
YEAR END BALANCES
Assets $1,078,298 $1,037,134 3.97 % 8.96
Earning assets 972,402 935,166 3.98 8.45
Loans 781,321 678,746 15.11 13.53
Deposits 820,226 824,024 (.46) 5.57
Shareholders' equity 110,678 108,210 2.28 11.75
PER COMMON SHARE
Net income (basic) $2.36 $2.22 6.31 % 1.79
Book value 24.24 23.59 2.76 6.79
Cash dividends paid 1.00 1.00 - .82
Closing market price 37.90 27.75 36.58 1.03
FINANCIAL RATIOS
Return on average assets 1.03% 1.00
Return on average equity 9.82% 9.75
Average equity to average assets 10.44% 10.26
Price to earnings (x) 16.06x 12.50x
Price to book value (x) 1.56x 1.18x
NONFINANCIAL DATA
Estimated total shareholders 2,429 2,443
Employees 436 416
Financial service offices 43 40
II-12
SHAREHOLDER SUMMARY
First M & F Corporation
And Subsidiary
Investment Data
December 31, 2003
- -------------------------------------------------------------------------------------------------------------
52-Week range $27.75 - $39.30
Closing stock price $37.90
Earnings per share (basic) $2.36
Book value per share $24.24
Shares outstanding 4,565,038
Stock appreciation since 12/98 1.03%
Stock and Dividend Performance
2003 2002 2001 2000 1999
- -------------------------------------------------------------------------------------------------------------
Price/earnings ratio 16.06x 12.50x 13.23x 11.03x 13.89x
Price/book value ratio 1.56x 1.18x .95x .80x 1.55x
Book value/share $24.24 $23.59 $21.68 $21.01 $19.41
Dividend payout ratio 42.37% 45.05% 64.52% 65.36% 46.30%
Historical dividend yield 3.60% 4.88% 5.93% 3.33% 2.78%
Quarterly Closing Common Stock
Price Ranges and Dividends Paid
First Second Third Fourth
- --------------------------------------------------------------------------------------------------------------
2003:
High $35.80 $39.30 $37.00 $39.11
Low 27.75 30.50 31.75 34.59
Close 35.80 32.71 35.65 37.90
Dividend .25.25 .25 .25 .25
- ---------------------------------------------------------------------------------------------------------------
2002:
High $24.50 $26.50 $27.00 $28.04
Low 20.50 22.60 22.02 25.85
Close 23.50 25.00 26.20 27.75
Dividend .25 .25 .25 .25
II-13
OTHER FINANCIAL DATA
First M & F Corporation
And Subsidiary
Change
------------------------
2003 2002
(Dollars in Thousands) 2003 2002 2001 Vs 2002 Vs 2001
- -----------------------------------------------------------------------------------------------------------------
COMPOSITION RATIOS
Earning assets to assets 90.18 % 90.17 % 90.14 % lbp 3bp
Loans to earning assets 80.35 72.58 72.04 777 54
Interest-bearing liabilities to earning assets 85.80 87.35 86.93 185) 42
Loans to total deposits 95.26 82.37 80.98 1,289 139
Noninterest-bearing deposits to total deposits 15.02 12.37 13.32 265 (95)
- -----------------------------------------------------------------------------------------------------------------
ALLOWANCE FOR LOAN LOSSES
Beginning balance $10,258 $8,426 $8,510 21.74% (.99%)
Provision for loan losses 3,802 4,495 4,415 (15.42) 1.81
Charge-offs (3,675) (3,305) (5,288) 11.20 (37.50)
Recoveries 506 642 789 (21.18) (18.63)
------------------------------------------------------------------
Net charge-offs (3,169) (2,663) (4,499) 19.00 (40.81)
------------------------------------------------------------------
Ending balance $10,891 $10,258 $8,426 6.17% 21.74%
- -----------------------------------------------------------------------------------------------------------------
COMPOSITION OF RISK ASSETS
Nonaccrual loans $4,517 $1,582 $1,825 185.52% (13.32%)
Foreclosed property 802 950 1,077 (15.58) (11.79)
------------------------------------------------------------------
Nonperforming assets $5,319 $2,532 $2,902 110.07% (12.75%)
------------------------------------------------------------------
Accruing loans past due 90 days $1,531 $2,169 $1,958 (29.41%) 10.78%
- -----------------------------------------------------------------------------------------------------------------
ASSET QUALITY RATIOS
Net charge-offs to average loans .43% .40% .69% 3bp (29bp)
Nonaccrual loans to total loans .58 .23 .28 35 (5)
Nonperforming assets to:
Loans and foreclosed property .68 .37 .44 31 (7)
Total assets .49 .24 .28 25 (4)
Allowance for loan losses to total loans 1.39 1.51 1.27 (12) 24
Allowance for loan losses to nonaccrual 2.41x 6.48x 4.62x (407) 186
loans (x)
- -----------------------------------------------------------------------------------------------------------------
I-14
QUARTERLY FINANCIAL TRENDS (UNAUDITED)
First M & F Corporation
And Subsidiary
2003
----------------------------------------------------- 4th Qtr '03
First Second Third Fourth Vs
(Dollars in Thousands) Quarter Quarter Quarter Quarter 4th Qtr '02
- ----------------------------------------------------------------------------------------------------
Interest income $ 14,386 $ 14,290 $ 14,416 $ 14,826 (1.15%)
Interest expense 4,862 4,513 4,077 4,405 (16.71)
-------------------------------------------------------------------
Net interest income 9,524 9,777 10,339 10,421 7.32
Provision for loan losses 920 963 959 960 (5.04)
Noninterest income 3,376 3,619 3,809 3,553 (4.21)
Noninterest expense 8,256 8,681 9,214 8,970 5.01
Income taxes 1,070 1,114 1,184 1,235 8.71
-------------------------------------------------------------------
Net income $ 2,654 $ 2,638 $ 2,791 $ 2,809 2.89%
- ----------------------------------------------------------------------------------------------------
Per common share: $.57 $.57 $.61 $.61 3.39%
Net income (basic)
Net income (diluted) $.57 $.57 $.60 $.61 3.39%
- ----------------------------------------------------------------------------------------------------
Cash dividends .25 .25 .25 .25 -
- ----------------------------------------------------------------------------------------------------
2002
----------------------------------------------------- 4th Qtr '02
First Second Third Fourth Vs
Quarter Quarter Quarter Quarter 4th Qtr '01
- ----------------------------------------------------------------------------------------------------
Interest income $ 15,679 $ 15,443 $ 15,752 $ 14,999 (10.29%)
Interest expense 6,620 6,173 5,620 5,289 (32.50)
- ----------------------------------------------------------------------------------------------------
Net interest income 9,059 9,270 10,132 9,710 9.30
Provision for loan losses 1,200 1,280 1,004 1,011 (15.75)
Noninterest income 3,274 3,314 3,791 3,709 6.76
Noninterest expense 7,928 8,078 8,846 8,542 4.82
Income taxes 896 897 1,206 1,136 19.58
- ----------------------------------------------------------------------------------------------------
Net income $ 2,309 $ 2,329 $ 2,867 $ 2,730 32.59%
- ----------------------------------------------------------------------------------------------------
Per common share:
Net income (basic) $.50 $.51 $.62 $.59 31.11%
Net income (diluted) $.50 $.51 $.62 $.59 31.11%
- ----------------------------------------------------------------------------------------------------
Cash dividends .25 .25 .25 .25 -
- ----------------------------------------------------------------------------------------------------
II-15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
First M & F Corporation and Subsidiary
Financial Condition
The purpose of this discussion is to focus on significant changes in financial condition and results of operations of the Company and its banking subsidiary during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and selected financial data presented elsewhere in this report and in the enclosed Financial Summary for First M & F Corporation and Subsidiary.
Forward-Looking StatementsThis Report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements appear in a number of places in this Report and include all statements regarding the intent, belief or current expectations of the Company, its directors or its officers with respect to, among other things: (i) the Company’s financing plans; (ii) trends affecting the Company’s financial condition or results of operations; (iii) the Company’s growth strategy and operating strategy; and (iv) the declaration and payment of dividends. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors discussed herein and those factors discussed in detail in the Company’s filings with the Securities and Exchange Commission.
Critical Accounting Policies and EstimatesManagement’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of the financial statements requires management to make certain judgments and assumptions in determining accounting estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and obligations. Management evaluates these judgments and estimates on an ongoing basis to determine if changes are needed. Management believes that the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.
(1) Allowance for loan losses (2) Goodwill, intangible assets and related impairment (3) Contingent liabilitiesAllowance for loan losses
The Company’s policy is to maintain the allowance for loan losses at a level that is sufficient to absorb estimated probable losses in the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Management’s estimate is reflected in the balance of the allowance for loan losses. Changes in this estimate can materially affect the provision for loan losses, and thus net income.
Management of the Company evaluates many factors in determining the estimate for the allowance for loan losses. Historical loan losses by loan type and loan grade are a significant factor in estimating future losses. Management reviews loan quality on an ongoing basis to determine the collectibility of individual loans and reflects that collectibility by assigning loan grades to individual credits. The grades will generally determine how closely a loan will be monitored on an ongoing basis. A customer’s payment history, financial statements, cash flow patterns and collateral, among other factors, are reviewed to determine if the loan has potential losses. Concentrations of credit by loan type and collateral type are reviewed to determine exposures and risks of loss. General economic factors as well as economic factors for individual industries or factors that would affect certain types of loan collateral are reviewed to determine the exposure of loans to economic fluctuations. The Company also has a loan review department that audits types of loans as well as geographical segments to determine credit problems and loan policy violations that require the attention of management. All of these factors are used to determine the adequacy of the allowance for loan losses and adjust its balance accordingly.
The allowance for loan losses is increased by the amount of the provision for loan losses and by recoveries of previously charged-off loans. It is decreased by loan charge-offs as they occur when principal is deemed to be uncollectible.
II-16The policy of First M & F Corporation is to assess goodwill for impairment at the reporting unit level on an annual basis. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Accounting standards require management to estimate the fair value of each reporting unit in making an annual assessment of impairment. Management performs this assessment as of January 1 of each year.
Impairment of goodwill is recognized by a charge against earnings and is to be shown as a separate line item in the non-interest expense section of the consolidated statement of income.
The estimate of fair value is dependent on such assumptions as: (1) future cash flows determined from the budget, strategic plan, and forecasts of growth, and (2) discount rates and earnings multiples used to determine the present value of those cash flows. Management uses a model similar to those used to evaluate potential mergers and acquisitions. The original valuations performed in 2002 resulted in no impairment being recognized. A subsequent update in 2003 resulted in no impairment charge.
Contingent liabilitiesAccounting standards require that a liability be recorded if management determines that it is probable that a loss has occurred and the loss can be reasonably estimated. Management must estimate the probability of occurrence and estimate the potential exposure of a variety of contingencies such as health claims, legal claims, tax liabilities and other potential claims against the Company’s assets or requirements to perform services in the future.
Management’s estimates are based upon their judgment concerning future events and their potential exposures. However, there can be no assurance that future events, such as changes in a regulator’s position or court cases will not differ from management’s assessments. When management, based upon current facts and expert advice, believes that an event is probable and reasonably estimable, it accrues a liability in the consolidated financial statements. That liability is adjusted as facts and circumstances change and subsequent assessments produce a different estimate.
SummaryNet income for 2003 was $10,892,053, or $2.36 basic and $2.35 diluted per share as compared to $10,234,949, or $2.22 per share in 2002. Net income for 2002 was up from net income in 2001 of $7,153,265, or $1.55 per share. Income tax expense increased by $.468 million in 2003 as compared to 2002 due to lower tax-exempt earnings as a percent of total earnings in 2003 and increased by $1.073 million in 2002 as compared to 2001 due to higher pre-tax earnings.
In the first quarter of 2003 the Company opened a loan production office in Olive Branch. In the second quarter of 2003 the Company opened a new business, M & F Business Credit, Inc., in Memphis, Tennessee. The business is a wholly owned subsidiary of M & F Bank and is an asset-based lending operation with a target market area of the southeastern United States. In the third quarter of 2003 the Company opened an additional branch in Tupelo, giving it four (4) locations in the Tupelo market. The location is a former bank building purchased in 2002 and remodeled in 2003.
In 2002 the Company closed a small drive-in branch in Grenada and acquired an insurance agency in Brandon. The Company also acquired land adjacent to a shopping center in Rankin County in the third quarter of 2002, anticipating building a full service branch in the third or fourth quarter of 2003. Construction was begun in the late summer of 2003, with the branch expected to open in the first quarter of 2004.
In 2001 the Company acquired the Madison County book of business from an independent insurance agency. A new agent was hired and the new business integrated into the Madison office of M & F Insurance Group, Inc., the Bank’s insurance agency subsidiary.
The Bank opened a second rented location in Southaven in the third quarter of 2001. Construction of a new headquarters building in Kosciusko was begun in late 2000 and completed in the fall of 2001.
The Company added automated platform technology in June of 2002 and an automated teller transaction processing system in December of 2002 to enhance the efficiency and accuracy of the customer service representatives and tellers. In November and December of 2003 the mainframe processing system was enhanced with faster equipment as well as the addition of a storage area network. These additions were made with expectations for lower ongoing combined lease, maintenance and depreciation costs.
II-17Total assets increased by 3.97% in 2003 to end the year at $1.078 billion. Total assets increased by 1.85% in 2002 to end the year at $1.037 billion. Total assets fell by .21% in 2001 to end the year at $1.018 billion. The compounded annual growth rate for total assets for the last five (5) years was 8.96%, while the compounded growth rate for deposits was 5.57%.
Earning AssetsThe average earning asset mix for 2003 was 75.40% in loans, 22.12% in investments, and 2.48% in short-term funds. The average earning asset mix for 2002 was 70.74% in loans, 27.38% in investments, and 1.88% in short-term funds. The average earning asset mix for 2001 was 69.98% in loans, 27.30% in investments, and 2.72% in short-term funds. Loans grew by 15.11% in 2003 while deposits decreased. Loans grew by 2.64% in 2002 while deposits grew by .91%. Loan growth was slightly less than deposit growth in 2001. Non-interest bearing deposits grew by 20.88% in 2003, while they fell by 6.3% in 2002 and grew by 24.3% in 2001. Average non-interest bearing deposits grew by 7.85% in 2003 and by 7.26% in 2002. The following table shows the volume changes in loans and deposits over the last four (4) years.
(Dollars in Thousands) 2003 2002 2001 2000
---------------------------------------------
Net increase in loans $102,575 $17,464 $28,073 $24,259
Net increase in deposits (3,798) 7,407 29,063 (2,387)
Ratio of loan growth to deposit growth - 235.78% 96.59 -
Loan growth was strong in 2003 after being weak in 2002 and 2001. Loans grew by 15.11 % in 2003, by 2.64% in 2002, and by 4.43% in 2001. Consumer loans decreased from 2001 through 2003 by approximately $14 million per year. However, residential loan balances increased by $21.559 million from 2002 to 2003 after decreasing from 2001 to 2002. Commercial real estate-secured loans grew by over 11.57% in 2002 and by 29.53% during 2003. Commercial loans not secured by real estate increased by 19.41% in 2003 after increasing by 9.45% in 2002. Much of the commercial real estate related loan growth in 2003 came in the Madison, Lee and Desoto county markets as the Company expanded the commercial lending staff in those areas. The new asset-based lending operation in Memphis, M & F Business Credit, Inc., accounted for $6.815 million, or 7.24% of the non-real estate related commercial loan growth. The Company introduced a home equity line promotion in 2001 that resulted in an increase in those balances of $12.8 million for the year. An additional $5.7 million in growth was attained in 2002, while there was no growth in 2003. The Company’s strategy is to continue to grow the loan portfolio in markets that have expanding economies. As a secondary source of loan growth, the Company may purchase participations in loans that are within the loan policies and the Company’s credit expertise. The Company has plans for additional full-service branch expansion in 2004 in Rankin County and Desoto County. Although the short-term effect of de novo expansion on earnings can be negative, management believes that this strategy creates long-term shareholder value.
Investment SecuritiesThe Company’s investment portfolio decreased by 20.56% in 2003, by 5.69% in 2002, and by 5.27% in 2001. The 2002 and 2001 decreases were primarily attributable to the maturing of investments in a leverage portfolio from a 1999 bank acquisition. The 2003 decrease was used to provide funding for the loan portfolio. Most of the cash flows diverted to the 2003 lending effort were generated from mortgage-backed securities. In 2002 and 2003 the Company increased its investments in U.S. Government agency securities to provide a high-quality liquidity portfolio, 21.60% of which matures within 2004. In 2001 the Company increased its percentage of investments in municipal bonds while decreasing its percentage allocated to Government securities. As of December 3 1, 2003, municipal securities represented 31.70% of total debt securities as compared to 25.13% at December 31, 2002 and 26.01% at December 31, 2001. The increase in the percentage allocated to municipals in 2003 was more a result of the decreased size of the portfolio as the mortgage-backed securities paid down than it was a result of a change in strategy.
Deposits and BorrowingsDeposits decreased by .46% in 2003 after growing by .91 % in 2002 and 3.69% in 2001. NOW and MMDA deposits increased while certificates of deposit decreased in 2002, primarily due to the low interest rate environment. The increase in 2001 occurred primarily in demand and money market accounts as depositors sought liquidity in the lower rate environment. The Company offered bonus-rate certificate of deposit products for 36 and 60-month maturities during 2002 to try to extend the average maturity life of the deposit base and reduce interest rate sensitivity.
The decrease in deposits for 2003 was primarily in the NOW and MMDA category, which fell by $19.127 million after dominating the previous year’s deposit growth. The NOW and MMDA decrease in 2003 was primarily due to a reduction of $14.018 million in state and municipality deposits. Certificate of deposit balances remained flat in 2003 while non-interest bearing demand deposits increased by 20.88%. Certificates of deposit of states and municipalities increased by $23.703 million in 2003 while consumer and commercial customer certificates of deposit decreased by $24.139 million. NOW and MMDA balances grew by 25.38% in 2002, while certificates of deposit decreased by 9.92%. Deposit growth in 2001 was primarily in demand, NOW and MMDA accounts, as customers moved funds out of certificates of deposit due to the decrease in certificate of deposit rates offered during 2001. Short-term Treasury rates fell by 422 basis points in 2001, by 51 basis points in 2002 and by 30 basis points in 2003. This pressure, combined with a poor stock market in 2001 and 2002 caused funds to move out of equity securities and time deposits into more liquid deposit accounts.
II-18The Company made a decision to price in the bottom quartile of the market during 2002 and 2003 for certificates of deposit. This resulted in certificate of deposit decreases in 2002 and 2003. The Company used certain longer-term specially priced certificate of deposit promotions to offset some of the decreases in 2002 and 2003 and also to extend the average maturity of the certificate of deposit portfolio. Management monitors liquidity on a weekly and monthly basis to determine if pricing strategies need to be adjusted or other sources of liquidity need to be accessed.
Other borrowings increased by $50.891 million after decreasing by $2.493 million in 2002 and by $23.998 million from 2000 to 2001. The increase in 2003 was used along with investment maturities to fund loan portfolio growth. The 2001 and 2002 decreases were due to reductions in debt related to an investment leverage program that was reduced as investments matured. Borrowings were used in 2002 as an alternative to deposits to fund loan production while loan growth in 2001 was provided primarily through deposit funding. The Company uses wholesale funding sources such as the Federal Home Loan Bank to provide the liquidity needed for loan growth. However, the long-term strategy of the Company is to primarily fund loan growth through deposit growth first, with borrowings used when deposit funding is uneconomical. During 2002 and 2003 the Company took advantage of occasions when borrowing rates were lower than comparable certificate of deposit rates.
Liquidity and Interest Rate Sensitivity ManagementLiquidity is the ability of a bank to convert assets into cash and cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet day-to-day cash flow requirements of customers, whether they wish to withdraw funds or to borrow funds to meet their capital needs. The Company was sufficiently liquid in 2001 to fund loan growth without additional borrowings. Historically, deposit growth has been sufficient to provide for the Company’s liquidity needs. In 2002 the Company used borrowings as well as deposits due to lower demand by customers for time deposit products and to the availability of low-cost funds in the Federal Home Loan Bank lines. In 2003 the Company continued to use low-cost Federal Home Loan Bank borrowings to fund loan growth. The Company has sufficient lines available through the Federal Home Loan Bank and correspondent banks to meet all anticipated liquidity needs. However, it is the Company’s strategy to balance the use of deposits and debt as funding sources for asset growth.
The Company announced a stock repurchase plan in August of 2002 targeting the repurchase of 184,590 shares of stock from September of 2002 through September of 2004. Through December 31, 2002, the Company had repurchased 27,738 shares at an average price of $27.21 per share. The total cost of the 2002 purchases was $755 thousand. The Company terminated the 2002 plan in March of 2003 and replaced it with a 12-month plan to repurchase up to 240,000 shares through February, 2004. The decision to accelerate the plan was made after considering the exercise of 83,518 options in January and February of 2003. The resulting debt from the program will be paid off through dividends received by the Company from M & F Bank. The repurchase program has not had any negative effect on liquidity. The following tables show the repurchase and option exercise activity for 2003.
August, 2002 Repurchase Plan - ------------------------------------------------------------------------------------------- Month Shares Purchased Average Price - ------------------------------------------------------------------------------------------- January 18,000 29.13 February 14,500 31.82 March, 2003 Repurchase Plan - ------------------------------------------------------------------------------------------- Month Shares Purchased Average Price - ------------------------------------------------------------------------------------------- March 44,854 33.45 April 10,000 34.92 May 5,000 35.00 June 30,000 34.80 July 20,000 33.85 August 0 0.00 September 5,000 36.75 October 12,500 36.62 November 10,000 36.30 December 0 0.00 - ------------------------------------------------------------------------------------------- Total For 2003 169,854 33.77 - -------------------------------------------------------------------------------------------II-19
2003 Options Exercised - ------------------------------------------------------------------------------------------- Month Shares Purchased Average Price - ------------------------------------------------------------------------------------------- January 51,390 26.60 February 32,128 27.21 March 47,927 27.00 April 15,327 27.92 September 500 25.39 November 574 25.39 - ------------------------------------------------------------------------------------------- Total For 2003 147,846 26.99 - -------------------------------------------------------------------------------------------
Interest rate sensitivity is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities. Interest rate sensitivity management focuses on repricing relationships of these assets and liabilities during periods of changing market interest rates. Management seeks to minimize the effect of interest rate movements on net interest income. The asset-liability management committee monitors the interest-sensitivity gap on a monthly basis. The Company embarked on a strategy in 2002 and 2003 to increase the rate sensitivity of assets while reducing the sensitivity of liabilities. This was done by reducing the maturity terms of loans made, match funding certain other long-term loans originated, as well as by purchasing shorter-maturity securities. The Company also used long-term CD promotions and FHLB borrowings to increase the average maturity of the liability portfolio. These initiatives were taken with the anticipation of a rising interest rate environment at the end of the current soft economic cycle. At the end of 2003 the one-year repricing gap stood at + 3.85% as compared to + 1.72% at the end of 2002 and -7.40% at the end of 2001. The Company targets its one year repricing gap at between + 7.5% and 7.5%.
Capital ResourcesCapital adequacy is continuously monitored by the Company to promote depositor and investor confidence and provide a solid foundation for future growth of the organization. The Company has kept the dividend payout ratio above 40%, ending 2003 with a 42.37% ratio, ending 2002 with a ratio of 45.05% and ending 2001 with a ratio of 64.52%. The high payout percentage has been due to the lower than historical earnings per share in 2000 and 2001, with earnings beginning to rebound in 2002 and 2003, as the Company maintained a $1.00 annual dividend rate for 1999 through 2003. The ratio of capital to assets stood at 10.26% at December 31, 2003, 10.43% at December 31, 2002 and 9.83% at December 31, 2001, with risk-based capital ratios well in excess of the regulatory requirements. The lack of significant growth from 2000 through 2003 was a contributing factor to the improvement of the capital ratio from 8.86% at December 31, 1999. The Company has sufficient lines of credit at commercial banks to raise additional funds if needed. The Company’s stock is publicly traded on NASDAQ, also providing an avenue for additional capital if it is needed.
RESULTS OF OPERATIONS Net Interest IncomeNet interest income is the largest component of the Company’s net income and represents income from interest earning assets less the cost of interest bearing liabilities. Net interest income was $40.061 million in 2003 as compared to $38.171 million in 2002 and $32.965 million in 2001. The improvement in 2003 was due to increased loan volumes and decreased costs of deposits and borrowings. Average loans outstanding increased from $660.529 million in 2002 to $730.133 million in 2003. Interest and fees on loans decreased from 2002 to 2003 due to decreasing rates, as loan yields fell from 7.44% in 2002 to 6.67% in 2003. Interest expense decreased by $5.845 million from 2002 to 2003 as liability costs decreased to 2.14% in 2003 from 2.93% in 2002. Another improvement in 2003 came from non-interest bearing funding sources such as demand deposits and capital. Average earning assets grew by $32.818 million in 2003 while average interest bearing liabilities increased by $24.732 million. The difference was made up through retained earnings and non-interest bearing deposits. The improvement in 2002 was due to the ability of the Company to take advantage of the trend of decreasing interest rates. Earning asset yields decreased by 100 basis points in 2002 while liability costs decreased by 170 basis points. Therefore, while interest and fees on loans decreased by $5.994 million in 2002, interest on deposits decreased by $11.985 million. The low growth in 2001 was due mainly to slow loan growth. Loan yields decreased in 2001, 2002 and 2003 due to competitive pressures in 2002 and 2003 as well as the lower rate environment from 2001 through 2003.
Provision for Loan LossesDuring 2003 the Company’s provision decreased to $3.802 million from $4.495 million in 2002 and $4.415 million in 2001. The 2001 provision included an additional accrual of $800 thousand that was needed to replenish the allowance following a single
II-20customer charge-off in May, 2001 of $2 million. The remaining increase in the allowance for loan losses in 2002 and 2001 was due to the increased size of the portfolio. Loan loss accruals were reduced in 2003 after a normal year of net charge-offs in 2002. Net charge-offs were $3.169 million in 2003 as compared to $2.663 million in 2002 and $4.499 million in 2001. Net charge-offs as a percentage of average loans were .43% in 2003, .40% in 2002, and .69% in 2001. The strategy of the Company is to maintain credit quality at levels that produce net charge-off percentages in the .30% to .35% range. The net charge-off percentage for 2003 would have been .36%, excluding one large write-down on some rental properties in Lee County. Nonaccrual loans as a percentage of total loans were .58% at the end of 2003,.23% at the end of 2002, and .28% at the end of 2001. The nonaccrual loan totals were typical except for the non-accruing loans on rental properties mentioned above of approximately $1.890 million. Management has a conservative approach to classifying loans internally for purposes of determining needed allowances. The percentage of allowances to total loans was 1.39% at December 31, 2003, 1.51% at December 31, 2002, and 1.27% at December 31, 2001.
Management reviews loan quality on a monthly basis, and makes determinations as to the adequacy of the allowance for loan losses on a quarterly basis. Classified and past due loans are monitored to determine if deterioration is occurring, and if corrective actions need to be taken. The following table shows the calculation of the allowance for loan loss for 2003 and 2002 based upon classified loans.
2003 2002
-----------------------------------------------
Allowance Allowance
Balances Allocated Balances Allocated
-----------------------------------------------------------------
Doubtful 1,487 744 2,085 1,042
Substandard 6,910 1,662 7,117 1,423
Bankruptcy 5,650 707 3,930 590
Special mention 7,547 755 8,856 886
Other past due loans 3,796 190 4,054 203
General allowance 6,833 6,114
------------------------------------------------
10,891 10,258
Noninterest Income
Noninterest income for 2003 was $14.357 million as compared to $14.088 million in 2002 and $13.783 million in 2001. Deposit income increased by 2.25% in 2003, by 6.08% in 2002, and by 8.47% in 2001. The Company increased the pricing on certain deposit products and combined products in 2002 in an effort to reduce the number of products, focus on those products that serve the customers’ needs best, and align product pricing with the current market. The small increase in deposit revenues in 2003 was due to lower volumes in insufficient funds check activity and a 1.10% increase from 2002 in the number of checking accounts with balances under $100 thousand. Mortgage banking income increased by 8.11% in 2003 and was flat from 2001 to 2002. Mortgage loan originations increased to $75.051 million in 2003 from $64.341 million in 2002 and $60.382 million in 2001. The low interest rate environment was the main contributing factor to the increases. However, the presence of mortgage originators in economically strong markets such as Madison, Desoto, Rankin and Lee counties helped to spur growth as well. Agency commissions increased by 6.37% in 2003, by 13.81% in 2002, and by 7.42% in 2001. Annuity commissions fell by $29 thousand in 2003 while property and casualty commissions increased by $200 thousand and life and health commissions increased by $37 thousand. Pricing in the property and casualty industry continued to be high in 2003, and contributed to the increase in revenues. The insurance revenue increases in 2002 were driven by increased pricing throughout the industry in late 2001 and continuing into 2002. Commissions on annuity sales increased by approximately $100 thousand in 2002 as customers sought alternatives to deposit products to achieve better returns. The Company recognized approximately $300 thousand in security gains in 2001 as it disposed of certain mortgage-backed securities and invested in other securities that could collateralize a $10 million repurchase agreement. This transaction was executed to reduce the Company’s costs of borrowing. Another $125 thousand in gains were taken in Treasury, municipal and corporate securities in order to reallocate those funds into investments with more attractive durations. The 2002 increase in life insurance income includes approximately $65 thousand from a claim.
Noninterest ExpenseNoninterest expense increased to $35.121 million in 2003 from $33.394 million in 2002 and $32.118 million in 2001. Salary and benefit expenses increased by 3.73% in 2003 after increasing by 5.73% in 2002 and by 9.09% in 2001. Expenses for salaries and commissions alone were up by $1.193 million or 8.11 % in 2003 as compared to an increase of $471 thousand, or 3.31 % in 2002. The Company started an efficiency engagement in the fourth quarter of 2001 that reduced the number of full-time equivalent employees by 27.5 from the end of 2001 to June 30, 2002. During the second half of 2002 the Company increased the retail payroll by 15.5 full-time equivalent employees. This growth was primarily in the Madison, Kosciusko, Southaven, Brandon and
II-21Cleveland markets. Most of the increase was in the lending staff and helped result in improved loan production in 2003. During the first half of 2003, the Olive Branch loan production office was started with three (3) new employees. Four (4) additional staff were added in the mortgage lending area and four (4) were added in the back-room item processing area. The second quarter saw the opening of M & F Business Credit, Inc., an asset-based lending operation in Memphis, Tennessee with three (3) new employees. A new Treasury Services department was established in June with one (1) new employee and expanded to two (2) in the third quarter as the Company began to acquire lockbox customers. The retail branch system expanded by eight (8) full-time equivalent employees during the second half of 2003 in the Tupelo, Starkville, Oxford, Madison, and Rankin county branches. The Company also made $800 thousand in contributions to the pension plan in 2003 and $865 thousand in 2002. Pension plan expenses increased by $321 thousand from 2001 to 2002 and decreased by $270 thousand from 2002 to 2003. Health plan expenses decreased by $422 thousand from 2002 to 2003 as the Company experienced fewer health care claims in 2003.
Legal expenses increased by $345 thousand in 2003 and by approximately $400 thousand in 2002 due to litigation expenses on various cases as well as continuing expenses related to prior-year loan losses. Telecommunication expenses increased by $134 thousand in 2003 as the Company upgraded its data communications network. ATM and debit card network and processing expenses increased by $358 thousand in 2003 as the Company switched debit card providers and upgraded its debit card offering.
Amortization of intangible assets decreased by $1.248 million in 2002 as goodwill amortization was discontinued following the implementation of a new accounting standard. Under the new standard, goodwill is tested for impairment annually. The Company performed its impairment tests in the first quarters of 2002 and 2003, with no impairment charge required. Other expense increases in 2001 were marketing expenses, which were up by $204 thousand and foreclosed asset expenses, which were up by $173 thousand.
Non-interest expenses as a percentage of average assets were 3.31% in 2003, 3.26% in 2002, and 3.18% in 2001. The Company’s efficiency ratio was 62.79% in 2003, 61.96% in 2002 and 66.15% in 2001.
Income TaxesThe Company’s effective tax rate was 28.71% in 2003, 28.78% in 2002, and 29.98% in 2001. The main factor in the 2001 through 2003 increase over historical rates was an increased percentage of pre-tax earnings being derived from taxable sources. The Company primarily uses tax-exempt securities and loans to provide tax benefits and does not use any exotic tax-shelter vehicles.
OFF-BALANCE SHEET ARRANGEMENTSThe Company’s primary off-balance sheet arrangements are in the form of loan commitments and operating lease commitments. At December 31, 2003 the Company had $108.985 million in unused loan commitments outstanding. Of these commitments, $75.254 million mature in one year or less. Lines of credit are established using the credit policy of the Company concerning the lending of money.
Letters of credit are issued to facilitate the borrowers’ business and are usually related to the acquisition of inventory or of assets to be used in the customers’ business. Letters of credit are generally secured and are underwritten using the same standards as traditional commercial loans. Most letters of credit expire without being presented for payment. However, the presentment of a letter of credit would create a loan receivable from the Bank’s loan customer. At December 31, 2003 the Company had $9.616 million in letters of credit issued and outstanding.
In the ordinary course of business the Company enters into rental and lease agreements to secure office space and equipment. The Company has a variety of lease agreements in place, all of which are operating leases. The largest lease obligations are for office equipment and mainframe computer systems.
The Company does not have any variable interest entities or other off balance sheet vehicles, obligations or derivatives as of December 31, 2003.
II-22The following table summarizes the obligations of the Company.
Payments Due by Period
---------------------------------------------------------------
(Dollars in Thousands) Less More
Than 1 1-3 3-5 Than 5
Contractual Obligations Total Year Years Years Years
- ---------------------------------------------------------------------------------------------------
Long-Term Debt $ 93,142 $ 15,618 $ 34,397 $ 23,790 $ 19,337
Capital Lease Obligations -
Operating Leases 2,741 764 1,263 681 33
Purchase Obligations
Other Long-Term Liabilities
- ---------------------------------------------------------------------------------------------------
Total $ 95,883 $ 16,382 $ 35,660 $ 24,471 $ 19,370
Long-term debt obligations represent borrowings from the Federal Home Loan Bank that have an original maturity in excess of one (1) year. Operating leases are primarily leases on office space and information technology. Leases on office space range from those that are month-to-month to 60-month leases. Most leases have options to renew for periods equal to the original term of the lease. Technology leases are all contractual and have remaining lives of 39 to 60 months. There are no bargain purchase options in any of the current leases.
Market risk comes in the form of risk to the net interest income of the Company as well as to the market values of the financial assets and liabilities on the balance sheet and the values of off-balance sheet activities such as commitments. The Company monitors interest rate risk on a monthly basis with quarterly sensitivity analyses. The following table shows the gap position of the Company at December 31, 2003, placing variable-rate instruments in the earliest repricing category. The cash flows for deposits without maturities are estimated based upon historical decay rates, averaged over increasing and decreasing rate periods.
Floating 1-12 months 1-5 years Over 5 years Total
- ------------------------------------------------------------------------------------------------------------
Short-term funds 950 2,554 3,504
Investments 66,786 84,643 36,148 187,577
Loans 128,167 242,070 363,468 47,616 781,321
- ------------------------------------------------------------------------------------------------------------
Total earning assets 129,117 311,410 448,111 83,764 972,402
NOW, MMDA & savings 66,343 22,349 233,151 321,843
Time deposits 250,659 124,533 375,192
Short-term borrowings 15,205 15,205
Other borrowings 44,509 58,187 19,337 122,033
- ------------------------------------------------------------------------------------------------------------
Total int. bearing liabilities 66,343 332,722 415,871 19,337 834,273
Rate sensitive gap 62,774 (21,312) 32,240 64,427 138,129
Cumulative gap 62,774 41,462 73,702 138,129 276,258
Cumulative % of assets 5.82% 3.85% 6.84% 12.81% 25.62%
Interest rate shock analysis shows that the Company will experience a 6 basis point decrease over 12 months in its net interest margin with an immediate and sustained 100 basis point decrease in interest rates. An immediate and sustained increase in interest rates of 100 basis points will result in a 4 basis point increase in net interest margin. The sensitivity of loan prices and the lack of sustainable deposit cost decreases are the primary drivers behind these simulation results.
II-23An analysis of the change in market value of equity shows how an interest rate shock will affect the difference between the market value of assets and the market value of liabilities. With all financial instruments being stated at market value, the ratio of the market value of equity to the market value of assets will fall by 20 basis points with an immediate and sustained increase in interest rates of 100 basis points. The ratio of the market value of equity to the market value of assets will increase by 20 basis points with an immediate and sustained decrease in interest rates of 100 basis points.
The Company has no hedging instruments or other derivative contracts in place at December 31, 2003.
II-24
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Shareholders
First M & F Corporation
Kosciusko, Mississippi
We have audited the accompanying consolidated statements of condition of First M & F Corporation and subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First M & F Corporation and subsidiary as of December 31, 2003 and 2002, and the results of their consolidated operations and their consolidated cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/ Shearer, Taylor & Co., P.A. Ridgeland, Mississippi January 30, 2004II-26
FIRST M & F CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CONDITION
December 31, 2003 and 2002
(In Thousands, Except Share Data)
ASSETS 2003 2002
--------------------------
--------------------------
Cash and due from banks $ 39,849 $ 43,329
Interest bearing bank balances 2,554 12,610
Federal funds sold 950 7,700
Securities available for sale, amortized 187,577 236,110
cost of $181,375 and $226,617
Loans, net of unearned income 781,321 678,746
Allowance for loan losses (10,891) (10,258)
--------------------------
Net loans 770,430 668,488
--------------------------
Bank premises and equipment 24,214 21,508
Accrued interest receivable 7,330 7,125
Other assets 45,394 40,264
--------------------------
$1,078,298 $1,037,134
--------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits $ 820,226 $ 824,024
Short-term borrowings 15,205 23,599
Other borrowings 122,033 71,142
Accrued interest payable 1,379 1,920
Other liabilities 7,732 7,583
--------------------------
Total liabilities 966,575 928,268
--------------------------
Noncontrolling joint venture interest 1,045 656
--------------------------
Stockholders' Equity:
Preferred stock:
Class A; 1,000,000 shares authorized - -
Class B; 1,000,000 shares authorized - -
Common stock of $5.00 par value. 15,000,000
shares authorized: 4,565,038 and 4,587,046 shares
issued 22,825 22,935
Additional paid-in capital 31,624 33,260
Retained earnings 53,873 47,585
Accumulated other comprehensive income 2,356 4,430
--------------------------
Total stockholders' equity 110,678 108,210
--------------------------
$ 1,078,298 $ 1,037,134
--------------------------
--------------------------
The accompanying notes are an integral part of these financial statements.
II-27
FIRST M & F CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2003, 2002 and 2001
(In Thousands, Except Share Data)
2003 2002 2001
-------------------------------------------
INTEREST INCOME:
Interest and fees on loans $ 48,587 $ 49,015 $ 55,009
Taxable investments 6,653 9,998 11,418
Tax-exempt investments 2,378 2,573 2,793
Federal funds sold 192 163 683
Interest bearing bank balances 108 124 417
-------------------------------------------
Total interest income 57,918 61,873 70,320
-------------------------------------------
INTEREST EXPENSE:
Deposits 13,399 19,799 31,784
Short-term borrowings 608 695 756
Other borrowings 3,850 3,208 4,815
-------------------------------------------
Total interest expense 17,857 23,702 37,355
-------------------------------------------
Net interest income 40,061 38,171 32,965
Provision for loan losses 3,802 4,495 4,415
-------------------------------------------
Net interest income after 36,259 33,676 28,550
provision for loan losses
-------------------------------------------
NONINTEREST INCOME: 7,683 7,514 7,083
Service charges on deposit accounts
Mortgage banking income 1,160 1,073 1,095
Agency commission income 3,471 3,263 2,867
Other fee income 951 741 1,060
Bank owned life insurance income 532 772 656
Gain on securities available for sale 7 30 426
Other income 553 695 596
-------------------------------------------
Total noninterest income 14,357 14,088 13,783
-------------------------------------------
NONINTEREST EXPENSES: 18,473 17,809 16,844
Salaries and employee benefits
Net occupancy expenses 2,129 2,010 1,850
Equipment and data processing expenses 3,696 3,579 3,363
Other expenses 10,823 9,996 10,061
-------------------------------------------
Total noninterest expenses 35,121 33,394 32,118
-------------------------------------------
Income before income taxes 15,495 14,370 10,215
Income taxes 4,603 4,135 3,062
-------------------------------------------
NET INCOME $ 10,892 $ 10,235 $7,153
-------------------------------------------
EARNINGS PER SHARE: $2.36 $2.22 $1.55
Basic
Diluted 2.35 2.22 1.55
-------------------------------------------
The accompanying notes are an integral part of these financial statements.
II-28
FIRST M & F CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2003, 2002 and 2001
(In Thousands)
2003 2002 2001
---------------------------------------
Net income $ 10,892 $ 10,235 $ 7,153
Other comprehensive income: (2,058) 4,108 1,563
Change in unrealized gains (losses) on securities
available for sale, net of tax of $1,226, $2,439
and $934
Reclassification adjustment for gains on securities (4) (19) (267)
available for sale included in net income, net of
tax of $3, $11 and $159
Minimum pension liability adjustment, net of tax (12) (812) (714)
of $7, $484 and $424
---------------------------------------
Other comprehensive income (2,074) 3,277 582
---------------------------------------
Total comprehensive income $ 8,818 $ 13,512 $7,735
---------------------------------------
---------------------------------------
The accompanying notes are an integral part of these financial statements.
II-29
FIRST M & F CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2003, 2002 and 2001
(In Thousands, Except Share Data)
Accumulated
Additional Other
Common Paid-In Retained Comprehensive
Stock Capital Earnings Income Total
------------------------------------------------------------
January 1, 2001 $ 23,074 $ 33,876 $ 39,422 $ 571 $ 96,943
Net income - - 7,153 - 7,153
Cash dividends ($1.00 per share) - - (4,615) - (4,615)
Net change - - - 582 582
------------------------------------------------------------
December 31, 2001 23,074 33,876 41,960 1,153 100,063
------------------------------------------------------------
Net income - - 10,235 - 10,235
Cash dividends ($1.00 per share) - - (4,610) - (4,610)
27,738 common shares repurchased (139) (616) - - (755)
Net change - - - 3,277 3,277
------------------------------------------------------------
December 31, 2002 22,935 33,260 47,585 4430 108,210
------------------------------------------------------------
Net income - - 10,892 - 10,892
Cash dividends ($1.00 per share) - - (4,604) - (4,604)
147,846 common shares issued in 739 3,251 - - 3,990
exercise of stock options
169,854 common shares repurchased (849) (4,887) - - (5,736)
Net change - - - (2,074) (2,074)
------------------------------------------------------------
December 31, 2003 $22,825 $31,624 $53,873 $2,356 $110,678
------------------------------------------------------------
------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
II-30
FIRST M & F CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001
(In Thousands)
--------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $10,892 $ 10,235 $ 7,153
Adjustments to reconcile net income 1,932 2,035 3,128
to net cash provided by operating activities:
Depreciation and amortization
Provision for loan losses 3,802 4,495 4,415
Net investment amortization 977 729 377
Gain on securities available for sale (7) (30) (426)
Earnings of noncontrolling joint venture interest 389 299 368
Deferred income taxes (330) (850) (3,544)
(Increase) decrease in: (205) 738 937
Accrued interest receivable
Cash surrender value of bank owned life insurance (532) (630) (656)
Income taxes receivable 278 (603) 988
Increase (decrease) in: (541) (1,040) (1,030)
Accrued interest payable
Income taxes payable (3,274) 3,274
Other, net (526) 427 86
--------------------------------------------
Net cash provided by operating activities 16,129 12,531 15,070
--------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities available for sale (33,980) (56,844) (57,689)
Sales of securities available for sale 4,063 8,936 11,888
Maturities of securities available for sale 74,189 67,974 61,634
Net (increase) decrease in: 10,056 (9,522) 23,437
Interest bearing bank balances
Federal funds sold 6,750 (5,100) (200)
Loans (106,698) (21,354) (34,298)
Bank premises and equipment (4,492) (1,770) (4,121)
(Purchases) sales of Federal Home Loan Bank stock (2,646) 4,116
Proceeds from sales of other real estate and other 1,427 1,417 1,658
repossessed assets
Net cash used for current and prior year acquisitions - (74) (123)
--------------------------------------------
Net cash provided by (used in) investing activities (51,331) (16,337) 6,302
--------------------------------------------
II-31
FIRST M & F CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001
(In Thousands)
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITES:
Net increase (decrease) in: $21,276 $ (6,830) $21,234
Non-interest bearing deposits
Money market, NOW and savings deposits (24,638) 52,150 64,426
Certificates of deposit (436) (37,913) (56,597)
Short-term borrowings (8,394) 7,141 (12,511)
Proceeds from other borrowings 76,100 26,500 8,449
Repayments of other borrowings (25,836) (28,993) (32,447)
Distributions to noncontrolling joint venture interest - (500) -
Cash dividends (4,604) (4,610) (4,615)
Common shares issued 3,990 - -
Common shares repurchased (5,736) (755) -
------------------------------------------
Net cash provided by (used in) financing activities 31,722 6,190 (12,061)
------------------------------------------
Net increase (decrease) in cash and due from banks (3,480) 2,384 9,311
Cash and due from banks at January 1 43,329 40,945 31,634
------------------------------------------
Cash and due from banks at December 31 $39,849 $43,329 $40,945
------------------------------------------
------------------------------------------
The accompanying notes are an integral part of these financial statements.
II-32
The accounting and reporting policies of First M & F Corporation (the Company) which materially affect the determination of financial position and results of operations conform to accounting principles generally accepted in the United States of America and general practices within the banking industry. A summary of these significant accounting and reporting policies is presented below.
Organization and OperationsThe Company is a one-bank holding company that owns 100% of the common stock of M & F Bank (the Bank) of Kosciusko, Mississippi. The Bank is a commercial bank and provides a full range of banking services through its offices in Mississippi. As a state chartered commercial bank, the Bank is subject to the regulations of certain Federal and state agencies and undergoes periodic examinations by those regulatory authorities.
Principles of ConsolidationThe consolidated financial statements of First M & F Corporation include the accounts of the Company and its wholly owned subsidiary, M & F Bank, and the accounts of the Bank’s wholly owned finance subsidiary, credit insurance subsidiary, general insurance agency subsidiaries, real estate subsidiary, asset based lending subsidiary and 51 % owned accounts receivable financing joint venture. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of EstimatesThe 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 at the date of the financial statements and the reported amounts revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses represents a significant estimate.
Comprehensive IncomeComprehensive income includes net income reported in the statements of income and changes in unrealized gain (loss) on securities available for sale and minimum pension liability reported as a component of stockholders’ equity. Unrealized gain (loss) on securities available for sale and minimum pension liability, net of deferred income taxes, are the only components of accumulated other comprehensive income for the Company.
Securities Available for SaleSecurities, which are available to be sold prior to maturity are classified as securities available for sale and are recorded at market value. Unrealized holding gains and losses are reported net of deferred income taxes as a separate component of stockholders’ equity.
Premiums and discounts are amortized or accreted over the life of the related security using the interest method. Interest income is recognized when earned. Realized gains and losses on securities available for sale are included in earnings and are determined using the specific amortized cost of the securities sold.
11-33Loans are stated at the principal amount outstanding, net of unearned income and an allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. Loan origination fees and direct loan origination costs are deferred and recognized over the life of the related loans as adjustments to interest income.
The Bank discontinues the accrual of interest on loans and recognizes income only as received when, in the judgment of management, the collection of interest, but not necessarily principal, is doubtful.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Bank measures impaired and restructured loans at the present value of expected future cash flows, discounted at the loan’s effective interest rate, or the fair value of collateral if the loan is collateral dependent.
Allowance for Loan LossesThe allowance for loan losses is established through provisions for loan losses charged against earnings. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is maintained at a level believed to be adequate by management to absorb estimated probable loan losses. Management’s periodic evaluation of the adequacy of the allowance for loan losses is based on estimated credit losses for specifically identified loans as well as estimated probable credit losses inherent in the remainder of the loan portfolio. Management considers a number of factors in estimating probable credit losses inherent in the loan portfolio, including: historical loan loss experience for various types of loans; composition of the loan portfolio; past due trends in the loan portfolio; current trends; current economic conditions; industry exposure and allowance allocation percentages for various grades of loans, with such grades being assigned to loans based on internal and external loan reviews, loan risk, loan performance, the estimated value of underlying collateral, evaluation of a borrower’s financial condition and other factors considered relevant in grading loans.
Management’s evaluation of the allowance for loan losses is inherently subjective as it requires material estimates. The actual amounts of loan losses realized in the near term could differ from the amounts estimated in arriving at the allowance for loan losses reported in the financial statements.
II-34Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Provisions for depreciation and amortization are computed principally using the straight-line method and charged to operating expenses over the estimated useful lives of the assets. Costs of major additions and improvements are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.
Other Real EstateOther real estate acquired through partial or total satisfaction of loans is carried at the lower of market value or the recorded loan balance at date of acquisition (foreclosure). Any loss incurred at the date of acquisition is charged to the allowance for loan losses. Gains or losses incurred subsequent to the date of acquisition are reported in current operations. Related operating income and expenses are reported in current operations.
Intangible AssetsThe Company adopted Statement of Financial Accounting Standards (SFAS) 142, “Goodwill and Other Intangible Assets,” effective January 1, 2002. Under SFAS 142, goodwill and intangible assets that have indefinite lives are not amortized, but are tested for impairment annually and when there is an impairment indicator. Goodwill impairment losses are reported in a company’s income statement. The Company has no intangible assets having indefinite lives other than goodwill. Prior to adoption of SFAS 142 on January 1, 2002, goodwill was being amortized on a straightline basis over 40 years and 15 years.
Intangible assets, such as core deposit intangibles, customer renewal lists and noncompete agreements with determinable useful lives are amortized over their respective useful lives.
II-35The Company has elected not to adopt the recognition provisions of SFAS 123, “Accounting for Stock-Based Compensation”, as amended by SFAS 148, which require a fair-value based method of accounting for stock options and similar equity awards. The Company elected to continue applying Accounting Principles Board Opinion 25, (APB 25) “Accounting for Stock Issued to Employees” and related interpretations in accounting for its stock compensation plans and, accordingly, does not recognize compensation cost. Had compensation cost for the Company’s stock option plan been determined based upon the fair value at the grant date for awards under the methodology prescribed under SFAS No. 123, the Company’s net income and earnings per share would have been reduced as shown in the table below. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions in 2003, 2002 and 2001: expected dividend yield of 5.00%; expected volatility of 22.57%, 22.57% and 23.85%; risk-free interest rate of 6.50%; and an expected life of 10 years. The estimated fair values of stock options at their grant date were $7.67 in 2003, $5.10 in 2002 and $4.07 in 2001.
Net income, as reported $ 10,892 $ 10,235 $ 7,153
Net income, proforma 10,855 10,171 7,047
---------------------------------------
Stock based compensation cost, net of income taxes:
As reported $ - $ - $ -
Pro forma 37 64 106
---------------------------------------
Earnings per share, as reported:
Basic $ 2.36 $ 2.21 $ 1.55
Diluted 2.35 2.22 1.55
---------------------------------------
Earnings per share, proforma:
Basic $ 2.36 $ 2.21 $ 1.54
Diluted 2.34 2.21 1.54
----------------------------------------
----------------------------------------
Income Taxes
The Company, the Bank and the Bank’s wholly owned subsidiaries, except for the credit insurance subsidiary, file consolidated Federal and state income tax returns. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Deferred income tax expense (benefit) is the result of changes in deferred tax assets and liabilities between reporting periods.
II-36In the accompanying consolidated statements of cash flows, the Company and subsidiary have defined cash equivalents as those amounts included in the statement of condition caption “Cash and Due from Banks.” The following supplemental disclosures are made related to the consolidated statements of cash flows:
2003 2002 2001
------------------------------------
Interest paid $18,398 $24,742 $38,385
Federal and state income taxes paid 4,655 8,862 2,344
Other real estate and repossessions 1,575 1,352 1,726
acquired in noncash foreclosures ------------------------------------
------------------------------------
Concentrations of Credit
Substantially all of the Company’s loans, commitments and stand by and commercial letters of credit have been granted to borrowers who are customers in the Company’s market area. As a result, the Company is subject to this concentration of credit risk. A substantial portion of the loan portfolio, as presented in Note 3, is represented by loans collateralized real estate. The ability of the borrowers to honor their contracts is dependent upon the real estate and general economic conditions in the Company’s market area.
Recent PronouncementsIn December, 2002, FASB issued SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” The Company adopted the disclosure requirements of SFAS 148 during the year ended December 31, 2002.
During the years ended December 31, 2003 and 2002, FASB issued SFAS 146, “Accounting for the Costs Associated with Exit or Disposal Activities,” SFAS 147, “Acquisitions of Certain Financial Institutions,” SFAS 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities,” SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” Financial Interpretation (FIN) 45, “Guarantor’s Accounting and Disclosure Requirements, Including Indirect Guarantees of Indebtedness of Others,” and FIN 46 (as revised), “Consolidation of Variable Equity Interests.” The Company’s adoption of these standards did not or is not expected to have a material impact on the consolidated financial statements.
ReclassificationsCertain reclassifications have been made to the 2002 and 2001 financial statements to be consistent with 2003 presentation.
II-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2: SECURITIES AVAILABLE FOR SALE
The following is a summary of the amortized cost and market value (book value) of securities available for sale
at December 31, 2003 and 2002:
Amortized Gross Unrealized Market
Cost Gain Loss Value
-----------------------------------------------------
December 31, 2003:
U. S. Treasury securities $ 532 $ 28 $ - $ 560
U.S. Government agencies 67,954 1,865 25 69,794
Mortgage-backed investments 49,986 1,542 2 51,526
Obligations of states and political subdivisions 57,503 2,685 117 60,071
Other 4,364 199 - 4,563
Equity securities 1,036 27 - 1,063
-----------------------------------------------------
$ 181,375 $ 6,346 $ 144 $ 187,577
-----------------------------------------------------
-----------------------------------------------------
December 31, 2002:
U. S. Treasury securities $ 1,037 $ 45 $ - $ 1,082
U.S. Government agencies 58,125 2,688 7 60,806
Mortgage-backed investments 104,121 3,782 35 107,868
Obligations of states and political subdivisions 56,955 2,825 138 59,642
Other 3,380 258 - 3,638
Equity securities 2,999 75 - 3,074
-----------------------------------------------------
$ 226,617 $ 9,673 $ 180 $ 236,110
-----------------------------------------------------
-----------------------------------------------------
Provided below is a summary of securities available for sale which were in an unrealized loss position and the length of time that individual securities have been in a continuous loss position at December 31, 2003. The Company believes that the deterioration in value is attributable to changes in market interest rates and not credit quality of the issuer. None of these impairments are other than temporary since the Company has the ability to hold these securities until such time as the values recover or until these securities mature.
Less Than 12 Months 12 Months or More Total
----------------------------------------------------------------------------
Market Unrealzed Market Unrealized Market Unrealized
Value Losses Value Losses Value Losses
-------- --------- -------- ---------- -------- ----------
U. S. Government agencies $ 4,054 $ 25 $ - $ - $ 4,054 $ 25
Mortgage-backed investments 952 2 - - 952 2
Obligations of states and
political subdivisions 3,594 31 430 86 4,024 117
-------- --------- -------- ---------- -------- ----------
$ 8,600 $ 58 $ 430 $ 86 $ 9,030 $ 144
-------- --------- -------- ---------- -------- ----------
-------- --------- -------- ---------- -------- ----------
II-38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 2: SECURITIES AVAILABLE FOR SALE - Continued
The amortized cost and market values of debt securities available for sale at December 31, 2003, by contractual
maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have
the right to call or prepay certain obligations with, or without, call or prepayment penalties. Equity
securities are not included since they have no stated maturity.
Amortized Market
Cost Value
---------- ----------
One year or less $ 24,810 $ 25,179
After one through five years 94,854 98,754
After five through ten years 9,457 9,827
After ten years 1,232 1,228
---------- ----------
130,353 134,988
Mortgage-backed investments 49,986 51,526
---------- ----------
$ 180,339 $ 186,514
---------- ----------
---------- ----------
The following is a summary of the amortized cost and market value of securities available for sale which were
pledged to secure public deposits, short-term borrowings and for other purposes required or permitted by law.
Amortized Market
Cost Value
---------- ----------
December 31, 2003 $ 152,351 $ 157,798
---------- ----------
---------- ----------
December 31, 2002 $ 151,672 $ 159,074
---------- ----------
---------- ----------
The following is a summary of gains and losses on securities available for sale:
2003 2002 2001
-----------------------------------------
Gross realized gains $ 36 $ 34 $ 436
Gross realized losses (29) (4) (10)
------ ------ ------
$ 7 $ 30 $ 426
------ ------ ------
------ ------ ------
II-39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3: LOANS
The Bank's loan portfolio includes commercial, consumer, agribusiness and residential loans throughout the State
of Mississippi, but primarily in its market area in Central Mississippi. The following is a summary of the
Bank's loan portfolio, net of unearned income of $1,116 and $1,319 at December 31, 2003 and 2002:
2003 2002
---------------------------
Real estate loans:
Residential $ 265,591 $ 244,032
Construction and land development 95,164 70,198
Farmland 44,959 30,078
Nonfarm nonresidential real estate 199,424 161,865
Commercial, financial and agricultural 112,443 94,178
Consumer 63,740 78,395
---------------------------
$ 781,321 $ 678,746
---------------------------
---------------------------
The following is a summary of nonperforming loans at December 31, 2003 and 2002:
2003 2002
--------------------------
Nonaccrual loans $ 4,517 $ 1,583
Loans past due 90 days or more (based on contractual
loan terms) and still accruing interest 1,531 2,170
--------------------------
$ 6,048 $ 3,753
--------------------------
--------------------------
II-40
NOTE TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 3: LOANS - Continued
The Bank has made, and expects in the future to continue to make, in the ordinary course of business, loans to
directors and executive officers of the Company and the Bank and to affiliates of these directors and officers.
In the opinion of management, these transactions were made on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and did
not involve more than normal risk of collectibility or at the time of the transaction. A summary of such
outstanding loans follows:
2003 2002
--------------------------
Loans outstanding at January 1 $ 5,612 $ 2,341
New loans 2,016 10,186
Repayments (3,551) (6,915)
--------------------------
Loans outstanding at December 31 $ 4,077 $ 5,612
--------------------------
--------------------------
NOTE 4: ALLOWANCE FOR LOAN LOSSES
Transactions in the allowance for loan losses are summarized as follows:
2003 2002 2001
-------------------------------------------
Balance at January 1 $ 10,258 $ 8,426 $ 8,510
Loans charged off (3,675) (3,305) (5,288)
Recoveries 506 642 789
-------------------------------------------
Net charge-offs (3,169) (2,663) (4,499)
-------------------------------------------
Provision for loan losses 3,802 4,495 4,415
-------------------------------------------
Balance at December 31 $ 10,891 $10,258 $ 8,426
-------------------------------------------
-------------------------------------------
II-41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 5: BANK PREMISES AND EQUIPMENT
The following is a summary of bank premises and equipment at December 31, 2003 and 2002:
2003 2002
---------------------------
Land $ 7,609 $ 5,100
Buildings 20,727 19,616
Furniture, fixtures and equipment 16,219 15,519
Leasehold improvements 396 396
---------------------------
44,951 40,631
Less accumulated depreciation and amortization 20,737 19,123
---------------------------
$ 24,214 $ 21,508
---------------------------
---------------------------
Amounts charged to operating expenses for depreciation and amortization of bank premises and equipment were
$1,818 in 2003, $1,913 in 2002 and $1,757 in 2001.
NOTE 6: OTHER ASSETS
The following is a summary of other assets at December 31, 2003 and 2002:
2003 2002
----------------------------
Goodwill $ 16,348 $ 16,348
Amortized intangible assets, less accumulated
amortization of $1,521 and $1,407 489 603
Cash surrender value of bank owned life insurance 13,269 12,737
Federal Home Loan Bank stock 7,058 4,332
Other real estate, net 802 950
Deferred income tax 2,294 728
Other 5,134 4,566
----------------------------
$ 45,394 $ 40,264
----------------------------
----------------------------
As a condition to borrowing funds from the Federal Home Loan Bank of Dallas (FHLB), the Bank is required to purchase stock in the FHLB. No ready market exists for the stock, and it has no quoted market value. The investment in FHLB stock can only be redeemed by the FHLB at face value.
The Company adopted SFAS 142 effective on January 1, 2002. With the adoption of SFAS 142, goodwill and indefinite lived intangible assets are no longer amortized. Instead they are reviewed for impairment at least annually or when certain indicators are encountered to determine if they should be written down with an accompanying charge to earnings. The Company had no indefinite lived intangible assets other than goodwill.
II-42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 6: OTHER ASSETS - Continued
The following table summarizes the effect of the application of SFAS 142 on current earnings as compared to prior
years' earnings.
2003 2002 2001
-------------------------------------------
Net income, as reported $ 10,892 $ 10,235 $ 7,153
Goodwill amortization - - 1,199
-------------------------------------------
Adjusted net income $ 10,892 $ 10,235 $ 8,352
-------------------------------------------
-------------------------------------------
Earnings per share as reported $ 2.36 $ 2.22 $ 1.55
Goodwill amortization - - 0.26
-------------------------------------------
Adjusted earnings per share $ 2.36 $ 2.22 $ 1.81
-------------------------------------------
-------------------------------------------
Intangible assets, such as core deposit intangibles, customer renewal lists and noncompete agreements with a
determinable useful life continue to be amortized over their respective useful lives. Core deposit intangibles
have lives of ten years with a remaining average life of 0.3 years at December 31, 2003. Renewal list
intangibles have 15 year lives with a remaining average life of 11.4 years at December 31, 2003. Noncompete
agreement intangibles have 15 year lives with a remaining average life of 6.5 years at December 31, 2003.
The following is a summary of amortized intangible assets at December 31, 2003:
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
-------- ------------- ---------
Core deposit intangibles $ 1,130 $ 1,109 $ 21
Customer renewal lists 467 178 289
Noncompete agreements 413 234 179
-------- ------------- ---------
$ 2,010 $ 1,521 $ 489
-------- ------------- ---------
-------- ------------- ---------
Amortization expense for intangible assets having determinable useful lives amounted to $114 in 2003, $122 in
2002 and $172 in 2001. Estimated amortization expense for the five succeeding years at December 31, 2003 is as
follows:
2004 $ 76
2005 55
2006 55
2007 55
2008 55
----
----
II-43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 7: DEPOSITS
The following is a summary of deposits at December 31, 2003 and 2002:
2003 2002
---------------------------
Non-interest bearing $ 123,191 $ 101,915
Interest bearing:
Money market, NOW and savings accounts 353,292 377,930
Certificates of deposit of $100,000 or more 145,769 125,899
Other certificates of deposit 197,974 218,280
---------------------------
Total interest bearing 697,035 722,109
---------------------------
Total deposits $ 820,226 $ 824,024
---------------------------
---------------------------
Interest expense on certificates of deposit of $100,000 or more amounted to $3,419 in 2003, $4,288 in 2002 and
$8,178 in 2001.
At December 31, 2003, the scheduled maturities of certificates of deposit are as follows:
2004 $ 219,211
2005 66,664
2006 13,882
2007 32,149
2008 and thereafter 11,837
---------
$ 343,743
---------
---------
II-44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 8: SHORT-TERM BORROWINGS
The following is a summary of information related to short-term borrowings:
Weighted
Balance Outstanding Average Rate
---------------------------------- -------------------
Maximum Average At During At
Month End Daily Year End Year Year End
---------- -------- --------- ------- ---------
2003:
Federal funds purchased $ 8,600 $ 1,773 $ - 1.36% -
Securities sold under
agreements to repurchase 22,859 16,984 15,205 3.44% 3.57%
---------- -------- --------- ------- ---------
$ 31,459 $ 18,757 $ 15,205 ------- ---------
---------- -------- ---------
---------- -------- ---------
2002:
Federal funds purchased $ - $ 102 $ - 2.09% -
Securities sold under
agreements to repurchase 23,599 20,411 23,599 3.40% 2.95%
---------- -------- --------- ------- ---------
$ 23,599 $ 20,513 $ 23,599 ------- ---------
---------- -------- ---------
---------- -------- ---------
2001:
Federal funds purchased $ - $ 90 $ - 6.34% -
Securities sold under
agreements to repurchase 20,562 17,211 16,458 4.38% 3.82%
---------- -------- --------- ------- ---------
$ 20,562 $ 17,301 $ 16,458 ------- ---------
---------- -------- ---------
---------- -------- ---------
Federal funds purchased represent primarily overnight borrowings through relationships with correspondent banks.
Securities sold under agreements to repurchase generally have maturities of less than 30 days and are
collateralized by U. S. Treasury securities and securities of U. S. Government agencies and corporations.
II-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 9: OTHER BORROWINGS
The following is a summary of other borrowings at December 31, 2003 and 2002:
2003 2002
---------------------------
Company's line of credit in the amount of $15,000,000,
renewable annually; secured by approximately 29% of the
Bank's common stock; interest payable quarterly at .75 %
below the lender's base rate $ 5,892 $ 7,592
Bank's advances from Federal Home Loan Bank of Dallas, net
of unamortized purchase accounting adjustments of $215 and
$842 116,141 63,550
---------------------------
$ 122,033 $ 71,142
---------------------------
---------------------------
The Bank has advances from the Federal Home Loan Bank of Dallas (FHLB) under Blanket Agreements for Advances and
Security Agreements. These agreements allow the Bank to borrow funds from the FHLB to fund mortgage loan
programs and to satisfy certain other funding needs. The value of mortgage-backed securities and mortgage loans
pledged under these agreements must be maintained at not less than 115% and 150%, respectively, of the advances
outstanding. The following is a summary of these advances, exclusive of purchase accounting adjustments, at
December 31, 2003 and 2002:
2003 2002
-----------------------------
Single payment advances maturing
within 12 months of year end:
Balance $ 26,030 $ 12,382
Range of rates 1.18%-8.16% 1.49%-8.16%
Single payment advances maturing
after 12 months of year end:
Balance $ 23,030 $ 20,186
Range of rates 2.48%-8.16% 3.89%-8.48%
Range of maturities 2005-2010 2004-2010
Amortizing advances:
Balance $ 67,296 $ 31,824
Monthly payment amount 1,324 688
Range of rates 2.17%-8.48% 2.94%-7.83%
Range of maturities 2004-2020 2003-2020
II-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 9: OTHER BORROWINGS - Continued
Scheduled principal payments on FHLB advances, exclusive of purchase accounting adjustments, at December 31,
2003, are as follows:
2004 $ 38,832
2005 18,501
2006 15,896
2007 11,859
2008 11,931
After 2008 19,337
----------
$ 116,356
----------
----------
NOTE 10: EMPLOYEE BENEFIT PLANS
Pension Plan
The Bank has a defined benefit pension plan covering substantially all full time employees of the Bank and
subsidiaries. Benefits under this plan are based on years of service and average annual compensation for a five
year period. The Bank froze benefit accruals under this plan effective September 30, 2001. The following is a summary of the
plan's funded status:
2003 2002
--------------------------
Change in benefit obligation:
Projected benefit obligation at beginning of year $ 7,434 $ 6,582
Service cost - -
Interest cost 488 481
Actuarial (gain) loss 545 792
Benefit payments (429) (421)
Curtailment - -
--------------------------
Projected benefit obligation at end of year 8,038 7,434
--------------------------
Change in plan assets:
Fair value of plan assets at beginning of year 4,951 $ 5,521
Actual return on plan assets 802 (529)
Employer contributions 1,565 400
Benefit payments (429) (421)
Expenses (21) (20)
--------------------------
Fair value of plan assets at end of year 6,868 4,951
--------------------------
II-47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 10: EMPLOYEE BENEFIT PLANS - Continued
2003 2002
----------------------------
Funded status at measurement date:
Plan assets less than projected benefit obligation $ (1,170) $ (2,483)
Contributions after measurement date - 765
----------------------------
Funded status at end of year (1,170) (1,718)
Unrecognized net actuarial loss 3,266 3,293
Unrecognized transition asset (55) (64)
Unamortized prior service credit (293) (330)
----------------------------
Prepaid pension asset recognized 1,748 1,181
Pension accrual recognized (465) (465)
----------------------------
Net amount recognized $ 1,283 $ 716
----------------------------
----------------------------
The following is a summary of amounts recorded in the consolidated statements of condition:
2003 2002
----------------------------
Prepaid benefit cost $ 1,748 $ 1,181
Accrued benefit liability (2,918) (2,899)
Accumulated other comprehensive
income, before income taxes 2,453 2,434
----------------------------
Net amount recognized $ 1,283 $ 716
----------------------------
----------------------------
The following is a summary of information related to benefit obligations and plan assets:
2003 2002
----------------------------
Projected benefit obligation $ 8,038 $ 7,434
Accumulated benefit obligation 8,038 7,434
Fair value of plan assets 6,868 5,716
----------------------------
----------------------------
II-48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 10: EMPLOYEE BENEFIT PLANS - Continued
Net pension cost (benefit) included the following components:
2003 2002 2001
-------------------------------------------
Service cost $ - $ - $ 236
Interest cost 488 481 518
Expected return on plan assets (419) (447) (493)
Amortization of transition asset (9) (9) (44)
Amortization of prior service credit (37) (37) (37)
Recognized actuarial (gain) loss 210 73 30
-------------------------------------------
Net pension cost $ 233 $ 61 $ 210
-------------------------------------------
-------------------------------------------
Total expense recorded in the accompanying consolidated statements of income related to the pension plan included
the following components:
2003 2002 2001
-------------------------------------------
Net pension cost $ 233 $ 61 $ 210
Additional pension expense accrual - 465 -
Payments for expenses made on
behalf of the plan 93 71 66
-------------------------------------------
$ 326 $ 597 $ 276
-------------------------------------------
-------------------------------------------
The following is a summary of weighted average assumptions:
2003 2002 2001
-------------------------------------------
Discount rate 6.75% 7.50% 8.00%
Expected return on plan assets 7.50% 7.75% 8.00%
Rate of compensation increase (plan is frozen) -% -% 4.00%
-------------------------------------------
-------------------------------------------
II-49
The Company estimates the long-term rate of return on plan assets using historical returns, changes in asset mix, general economic conditions and industry practice. Historical annual returns on plan assets have ranged from losses of approximately 10% to gains in excess of 15%. The short-term volatility of these returns makes then an unreliable indicator of future long-term returns. Therefore, the historical plan rate of return is not used as a starting point, but rather as a guideline in determining the plan assumption for returns. The plan return was 18.6% in 2003. The mix of invested assets has changed over time from predominately fixed-income securities prior to 1997 to a mix of equity securities and fixed-income securities thereafter. The equity securities have brought more return volatility and higher expected returns to the portfolio. Management expects that the long-term equity market returns will approximate the past 50 years, which provided an average 12.3% return, based upon stock market historical data. Current and expected economic conditions also affect the determination of the estimate of long-term returns. Management also uses a survey of pension plan managers provided by a third party which indicates the rate of return assumptions that are predominant in the industry. Based upon these assumptions, management estimated long-term returns of 8% in 2001, given the expected asset mix. These return expectations have been reduced during the last two years due to economic factors, primarily the low interest rate environment. Management has determined that these assumptions are reasonable and are comparable to the return assumptions generally predominant in the industry.
The plan’s asset allocations at December 31, 2003 and 2002 by asset category are as follows:
2003 2002
------ ------
Interest bearing bank balances 6% 40%
Debt securities 32% 14%
Equity securities 62% 46%
------ ------
100% 100%
------ ------
------ ------
Equity securities included 9,434 and 9,034 shares of the Company’s common stock at December 31, 2003 and 2002.
The investment policy of the pension plan is based upon three principles: (1) the preservation of capital, (2) risk aversion, and (3) adherence to investment discipline. Investment managers should make reasonable efforts to preserve capital, understanding that losses may occur in individual securities. Investment managers are to make reasonable efforts to control risk, and will be evaluated regularly to ensure that the risk assumed is commensurate with the given investment style and objectives. Investment managers are expected to adhere to the investment management styles for which they were hired.
II-50The plan investment objectives are (1) income and growth, which is the primary objective, and the secondary objectives of (2) liquidity and (3) preservation of capital. The plan’s return objective is to achieve a balanced return of income and modest growth of principle. The goal of the plan is to achieve an absolute rate of return of 8% over the life of the plan. The secondary objectives ensure (1) the ability to meet all expected or unexpected cash flow needs by investing in securities which can be sold readily and efficiently and (2) the probability of loss of principle over the investment horizon is minimized, effectively emphasizing the minimizing of return volatility over the maximization of total return. Individual investment managers will be required to manage toward a market index, a blended index, or another target established by the Company’s Retirement Committee that reflects the expected style of management. Each individual portfolio manager is expected to display an overall level of risk in the portfolio which is consistent with the risk associated with the benchmark return. Risk is measured by the standard deviation of quarterly returns.
The following table outlines the target asset allocations in percentages for plan assets.
Minimum Maximum Preferred
--------------------------------------
Equities 50% 70% 60%
Fixed-income 30% 40% 35%
Cash 2% 8% 5%
Plan assets are ultimately managed to provide for benefit payments. This is done by providing for targeted returns, to assure that future benefit obligations will be provided for, by providing income production as well as principle growth, and by investing in assets that are liquid. The Company’s Retirement Committee monitors expected cash flows and modifies the investment targets and allocations to provide for those future needs.
Prohibited investment include commodities and futures contracts, private placements, options, limited partnerships, venture-capital investments, real estate properties, interest-only (IO), principal-only (PO) and residual tranche CMO’s and hedge funds. Prohibited transactions within the plan are short selling and margin transactions.
The Company expects to contribute $400 to the pension plan in 2004.
Profit and Savings PlanThe Bank has a profit and savings plan which includes features such as an Employee Stock Option Plan and a 401(k) plan which provides for certain salary deferrals, covering substantially all full time employees of the Bank and subsidiaries. The Bank matches employee 401(k) contributions equal to 50% of an employee’s first 5% of salary deferral. Total matching contributions accrued for this plan were $193 in 2003, $160 in 2002 and $133 in 2001. Additional contributions to the plan are at the discretion of the Board of Directors. Discretionary contributions accrued for this plan were $60 in 2003, $60 in 2002 and $40 in 2001.
At December 31, 2003 and 2002, the profit and savings plan owned 86,913 and 102,076 shares of the Company’s common stock.
II-51The Company implemented a stockholder approved Stock Option Plan, effective January 1, 1999, authorizing the grant of incentive stock options (ISO’s) to key employees and nonstatutory stock options (NSO’s) to members of the Board. The stated purpose of the plan is to provide incentives to key officers and directors by permitting them to purchase stock in the Company under the provisions of this plan. The maximum number of shares of stock that may be optioned or sold under the plan is 500,000 shares. Under the provisions of the plan, the Company and the participating employees and directors will execute agreements, upon the grant of options, providing each participant with an option to purchase stock within ten years of the date of the grant.
The following is a summary of stock option activity:
Weighted
Average
Outstanding Exercise
Options Price
---------- ---------
January 1, 2001 351,802 $ 28.36
Options granted 2,500 20.00
Options forfeited (6,500) 32.50
---------- ---------
December 31, 2001 347,802 28.22
---------- ---------
Options granted 3,000 25.25
Options forfeited (31,050) 27.08
---------- ---------
December 31, 2002 319,752 28.30
---------- ---------
Options granted 2,500 38.00
Options exercised (147,846) 26.99
---------- ---------
December 31, 2003 174,406 $ 29.56
---------- ---------
---------- ---------
The following is a summary of stock options outstanding at December 31, 2003:
Weighted Weighted Weighted
Average Average Average
Remaining Exercise Exercise
Contractual Price- Price-
Exercise Options Life Options Options Options
Price Range Outstanding (Years) Outstanding Exercisable Exercisable
------------------------------------------------------------------------------------------------------------
$ 20.00 - $ 20.25 5,000 6.83 $ 20.13 2,500 $ 20.15
25.39 - 28.68 93,406 3.47 27.04 88,506 27.09
31.75 - 35.75 76,000 4.59 32.90 60,800 32.90
------- ------- ------ ---- ------- ------ -------
------- ------- ------ ---- ------- ------ -------
II-52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 12: OTHER EXPENSES
Significant components of other expenses are summarized as follows:
2003 2002 2001
--------------------------------------------
Advertising and promotion $ 1,136 $ 1,007 $ 875
Communications 928 795 796
Postage and shipping 637 624 607
Professional fees 1,228 1,458 1,254
Stationery and supplies 716 762 816
Amortization 115 122 1,371
Other 6,063 5,228 4,342
--------------------------------------------
$ 10,823 $ 9,996 $ 10,061
--------------------------------------------
--------------------------------------------
NOTE 13: INCOME TAXES
The components of income tax expense (benefit) are as follows:
Federal State Total
--------------------------------------------
2003:
Current $ 4,385 $ 548 $ 4,933
Deferred (280) (50) (330)
--------------------------------------------
Total $ 4,105 $ 498 $ 4,603
--------------------------------------------
--------------------------------------------
2002:
Current $ 4,396 $ 589 $ 4,985
Deferred (724) (126) (850)
--------------------------------------------
Total $ 3,672 $ 463 $ 4,135
--------------------------------------------
--------------------------------------------
2001:
Current $ 5,784 $ 822 $ 6,606
Deferred (3,070) (474) (3,544)
--------------------------------------------
Total $ 2,714 $ 348 $ 3,062
--------------------------------------------
--------------------------------------------
II-53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 13: INCOME TAXES - Continued
The differences between actual income tax expense and expected income tax expense are summarized as follows:
2003 2002 2001
------------------------------------------
Amount computed using the Federal statutory
rates on income before income taxes $ 5,268 $ 4,886 $ 3,473
Increase (decrease) resulting from:
Tax exempt income, net of
disallowed interest deduction (795) (836) (864)
State income tax expense,
net of Federal effect 329 306 230
Life insurance income (181) (263) (223)
Nondeductible amortization - - 426
Other, net (18) 42 20
------------------------------------------
$ 4,603 $ 4,135 $ 3,062
------------------------------------------
------------------------------------------
The change in the net deferred taxes is a result of current period deferred tax expense (benefit), and changes in
accumulated other comprehensive income. The components of net deferred tax asset (liability) at December 31, 2003
and 2002, consist of the following:
2003 2002
---------------------------
Allowance for loan losses $ 4,035 $ 3,823
Loan fees 292 276
Purchase accounting adjustments 163 192
Accrued expenses 373 112
Minimum pension liability 915 908
Other 375 332
---------------------------
Total deferred tax assets 6,153 5,643
---------------------------
Fixed assets and depreciation (519) (553)
Federal Home Loan Bank stock dividends (506) (467)
Pension expense (479) (269)
Unrealized gain on securities available for sale (2,308) (3,537)
Other (47) (89)
---------------------------
Total deferred tax liabilities (3,859) (4,915)
---------------------------
$ 2,294 $ 728
---------------------------
---------------------------
II-54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 14: EARNINGS PER SHARE
The following table shows a reconciliation of earnings per share to diluted earnings per share:
2003 2002 2001
---------------------------------------------
Basic earnings per share:
Net income $ 10,892 $ 10,235 $ 7,153
---------------------------------------------
---------------------------------------------
Weighted average shares outstanding 4,608,023 4,611,926 4,614,784
---------------------------------------------
---------------------------------------------
Basic earnings per share $ 2.36 $ 2.22 $ 1.55
---------------------------------------------
---------------------------------------------
Diluted earnings per share:
Net income $ 10,892 $ 10,235 $ 7,153
---------------------------------------------
---------------------------------------------
Weighted average shares outstanding 4,608,023 4,611,926 4,614,784
Dilutive effect of stock options 26,381 - -
---------------------------------------------
Weighted averages shares outstanding 4,634,404 4,611,926 4,614,784
---------------------------------------------
---------------------------------------------
Diluted earnings per share $ 2.35 $ 2.22 $ 1.55
---------------------------------------------
---------------------------------------------
NOTE 15: STOCKHOLDERS' EQUITYThe Company is authorized to issue 1,000,000 shares of cumulative Class A voting preferred stock of no par value and 1,000,000 shares of cumulative Class B non-voting preferred stock of no par value. Dividend rates, redemption terms and conversion terms may be set by the Board of Directors.
Dividend Reinvestment and Stock Purchase PlanThe Dividend Reinvestment and Stock Purchase Plan authorizes the sale of up to 100,000 shares of the Company’s common stock from authorized, but unissued, shares or from shares acquired on the open market to shareholders who choose to invest all or a portion of their cash dividends and make optional cash payments of $50.00 to $5,000.00 per quarter. All shares for this plan have been purchased on the open market. The price of shares purchased on the open market is the average price paid for all shares purchased for all participants.
II-55The Company’s Board of Directors approved a common stock repurchase program on August 14, 2002, authorizing the repurchase of up to 184,590 shares of the Company’s outstanding common stock beginning in September, 2002. The authorization specifies that up to 92,295 shares may be repurchased in the first twelve months with an additional 92,295 shares authorized for repurchase during the second twelve month period. The timing and extent of any repurchases are subject to management’s discretion and will depend on market considerations. The Board will review the repurchase program after the first twelve months to allow for any needed adjustments. The reacquired shares will be held as authorized but unissued shares to be used for general corporate purposes.
The Company’s Board of Directors terminated the August 14, 2002, repurchase program and approved a common stock repurchase program on March 12, 2003, authorizing the repurchase of up to 240,000 shares of the Company’s outstanding common stock beginning in March, 2003. The authorization specifies that the shares will be repurchased within twelve months. The timing and extent of any repurchases are subject to management’s discretion and will depend on market considerations. The reacquired shares will be held as authorized but unissued shares to be used for general corporate purposes.
Accumulated Other Comprehensive IncomeThe following is a summary of the gross amounts of accumulated other comprehensive income and the related income tax effects:
Gross Tax Net
-------------------------------------------
December 31, 2003:
Net unrealized gain on securities available for sale $ 6,202 $ 2,308 $ 3,894
Minimum pension liability (2,453) (915) (1,538)
-------------------------------------------
$ 3,749 $ 1,393 $ 2,356
-------------------------------------------
-------------------------------------------
December 31, 2002:
Net unrealized gain on securities available for sale $ 9,493 $ 3,537 $ 5,956
Minimum pension liability (2,434) (908) (1,526)
-------------------------------------------
$ 7,059 $ 2,629 $ 4,430
-------------------------------------------
-------------------------------------------
December 31, 2001:
Net unrealized gain on securities available for sale $ 2,976 $ 1,109 $ 1,867
Minimum pension liability (1,138) (424) (714)
-------------------------------------------
$ 1,838 $ 685 $ 1,153
-------------------------------------------
-------------------------------------------
II-56
The Company, the Bank and the Bank’s subsidiaries are parties to lawsuits and other claims that arise in the ordinary course of business. Some of the lawsuits allege substantial claims for damages. The cases are being vigorously contested. In the regular course of business, management evaluates the estimated losses or costs related to litigation, and provision is made for anticipated losses whenever management believes that such losses are probable and can be reasonably estimated. At the present time, based upon present information, management cannot predict what effect, if any, the final resolution of pending legal proceedings will have on the Company’s consolidated financial position or results of operations.
Credit Related Financial InstrumentsThe Company is a party to credit related financial instruments with off balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit. These instruments involve, to varying degree, elements of credit and interest rate risk.
Commitments to extend credit are agreements to lend money to customers pursuant to certain specified conditions and generally have fixed expiration dates or other termination clauses. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. When making these commitments, the Company applies the same credit policies and standards as it does in the normal lending process. Collateral is obtained based upon the Company’s assessment of a customer’s credit worthiness.
Standby and commercial letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. When issuing letters of credit, the Company applies the same credit policies and standards as it does in the normal lending process. Collateral is obtained based upon the Company’s assessment of a customer’s credit worthiness.
The maximum credit exposure in the event of nonperformance for loan commitments and letters of credit is represented by the contract amount of the instruments. A summary of these instruments at December 31, 2003, is as follows:
Commitments to extend credit $ 108,985
Standby letters of credit 9,616
---------
---------
II-57
Federal banking regulations require that the Bank maintain certain cash reserves based on a percent of deposits. This requirement was $8,659 at December 31, 2003.
The Company and its subsidiary bank are subject to various regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items are calculated under regulatory accounting practices must be met. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Total Capital and Tier I Capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I Capital (as defined) to average assets (as defined). Management believes, as of December 31, 2003, that all capital adequacy requirements have been met.
As of December 31, 2003, the most recent notification by the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The Company’s and Bank’s actual capital amounts and ratios as of December 31, 2003 and 2002, are also presented in the table:
Actual Minimum Capital Well Capitalized
------------------ ----------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
---------- ----- -------- ----- --------- ------
December 31, 2003:
Total capital (to risk weighted assets):
Company $ 100,983 12.7% $ 63,793 8.0% $ - -
Bank 105,200 13.3% 63,519 8.0% 79,399 10.0%
Tier I capital (to risk weighted assets):
Company 90,992 11.4% 31,896 4.0% - -
Bank 95,251 12.0% 31,760 4.0% 47,640 6.0%
Tier I capital (to average assets):
Company 90,992 8.6% 42,298 4.0% - -
Bank 95,251 9.0% 42,257 4.0% 52,821 5.0%
---------- ----- -------- ----- --------- ------
---------- ----- -------- ----- --------- ------
II-58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 17: REGULATORY MATTERS - Continued
Actual Minimum Capital Well Capitalized
------------------ ------------------ -------------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------ --------- ------ -------- ------
December 31, 2002:
Total capital (to risk weighted assets):
Company $ 94,646 13.7% $ 55,270 8.0% $ - -
Bank 100,900 14.7% 54,993 8.0% 68,741 10.0%
Tier I capital (to risk weighted assets):
Company 85,958 12.4% 27,635 4.0% - -
Bank 92,254 13.4% 27,497 4.0% 41,245 10.0%
Tier I capital (to average assets):
Company 85,958 8.6% 27,635 4.0% - -
Bank 92,254 9.2% 40,018 4.0% 50,023 5.0%
--------- ------ --------- ------ -------- ------
--------- ------ --------- ------ -------- ------
Dividends paid by the Bank are the primary source of funds available to the Company for payment of dividends to its shareholders and other cash needs. Applicable Federal and state statutes and regulations impose restrictions on the amounts of dividends that may be declared by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits and other such items and, as a result, capital adequacy considerations could further limit the availability of dividends from the Bank. These restrictions are not anticipated to have a material effect on the ability of the Bank to pay dividends to the Company.
NOTE 18: ACQUISITIONSThe Company has acquired various general insurance agencies in Mississippi in transactions that were immaterial to the Company. The following table provides information concerning these insurance agency acquisitions completed during the three years ended December 31, 2003:
Common
Shares Method of
Acquisition Location Date Issued Accounting
----------- -------- ---- ------ ----------
Madison Insurance Co. Madison 01/01/01 - Purchase
Smith Insurance Agency, Inc. Madison 01/01/01 - Purchase
Thomas Insurance Agency, Inc. Brandon 07/01/02 - Purchase
II-59
SFAS 107, “Disclosures about Fair Value of Financial Instruments”, requires that the Company disclose estimated fair value for its financial instruments. However, such disclosures may be deemed not to be practicable for certain classes of financial instruments.
Because no market exists for a significant portion of the Company’s and Bank’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore, cannot be determined with precision. Changes in assumptions significantly affect the estimates and, as such, the derived fair value may not be indicative of the value negotiated in an actual sale and may not be comparable to that reported by other financial institutions.
In addition, the fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. Fair value estimates, methods and assumptions for significant financial instruments are set forth below:
Cash and due from banks, interest bearing deposits with banks and Federal funds sold - The net book value of these financial instruments approximates fair value due to the immediate availability or short maturity of these investments.
Securities available for sale - The fair value of these financial instruments is considered to be their market value as disclosed in note 2.
Loans - The fair value of variable rate loans that reprice frequently, and with no significant changes in credit risk, are based on carrying values. The fair value of fixed rate loans is estimated by discounting the future cash flows, using the current rates at which these loans would currently be made to borrowers with similar credit ratings and similar maturities. The carrying value of loans, net of the allowance for loan losses, is $770,430 and $668,488 and the estimated net fair value of loans is $765,359 and $678,041 at December 31, 2003 and 2002.
Deposits - The fair value of demand deposits, NOW accounts, money market accounts and savings deposits is the carrying amount at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows, using current market rates for deposits of similar maturities. The carrying value of deposits is $820,226and $824,024 and the estimated net fair value of deposits is $819,338 and $826,841 at December 31, 2003 and 2002.
Short-term and other borrowings - The net book value of the majority of these financial instruments approximates fair value due to the short term nature of these items or their applicable interest rates and repricing and repayment terms. The fair value of long term Federal Home Loan Bank (FHLB) advances in estimated by discounting the future cash flows, using current market rates for borrowings of similar terms and maturities. The carrying value of FHLB advances is $116,141 and $63,550 and the estimated fair value of FHLB advances is $116,235 and $65,021 at December 31, 2003 and 2002. The fair value of short-term and other borrowings is not materially different from their recorded book value at December 31, 2003 and 2002 as disclosed in note 8 and note 9.
Commitments to extend credit - Fair values for such commitments are typically based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the parties’ credit standing. The fair value of commitments to extend credit is not material.
II-60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 20: SUMMARIZED FINANCIAL INFORMATION OF FIRST M & F CORPORATION
Summarized financial information of First M & F Corporation (parent company only) is as follows:
STATEMENTS OF CONDITION
2003 2002
----------------------------
Assets
Cash $ 713 $ 521
Investment in subsidiary 114,937 114,505
Other assets 1,063 1,195
----------------------------
$ 116,713 $ 116,221
----------------------------
----------------------------
Liabilities and Stockholders' Equity
Note payable $ 5,892 $ 7,592
Other liabilities 143 419
Stockholders' equity 110,678 108,210
----------------------------
$ 116,713 $ 116,221
----------------------------
----------------------------
STATEMENTS OF INCOME
2003 2002 2001
-------------------------------------------
Income:
Dividends received from subsidiary $ 8,600 $ 6,550 $ 5,400
Equity in undistributed earnings of subsidiary 2,506 3,961 2,352
Other income 17 18 26
-------------------------------------------
Total income 11,123 10,529 7,778
-------------------------------------------
Expenses:
Interest 230 327 577
Other expenses 125 129 327
-------------------------------------------
Total expenses 355 456 904
-------------------------------------------
Income before income taxes 10,768 10,073 6,874
Income tax benefit 124 162 279
-------------------------------------------
Net income $ 10,892 $ 10,235 $ 7,153
-------------------------------------------
-------------------------------------------
II-61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE 20: SUMMARIZED FINANCIAL INFORMATION OF FIRST M & F CORPORATION - Continued
STATEMENTS OF CASH FLOWS
2003 2002 2001
--------------------------------------------
Cash flows from operating activities:
Net income $ 10,892 $ 10,235 $ 7,153
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed earnings of subsidiary (2,506) (3,961) (2,352)
Other, net (144) 145 136
--------------------------------------------
Net cash provided by operating activities 8,242 6,419 4,937
--------------------------------------------
Cash flows from investing activities:
Sale of land - 200 -
Cash paid related to prior year acquisitions - - (63)
--------------------------------------------
Net cash provided by (used in ) investing activities - 200 (63)
--------------------------------------------
Cash flows from financing activities:
Decrease in note payable (1,700) (1,000) (1,000)
Cash dividends (4,604) (4,610) (4,615)
Common shares issued 3,990 - -
Common shares repurchased (5,736) (755) -
--------------------------------------------
Net cash used in financing activities (8,050) (6,365) (5,615)
--------------------------------------------
Net increase (decrease) in cash 192 254 (741)
Cash at January 1 521 267 1,008
--------------------------------------------
Cash at December 31 $ 713 $ 521 $ 267
--------------------------------------------
--------------------------------------------
II-62
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As defined by the Securities and Exchange Commission in Exchange Act Rules 13a-15(e), a company’s “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms.
As of December 31, 2003 (the “Evaluation Date”), the Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in the Exchange Act Rules. Based on their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are sufficiently effective to ensure that material information relating to the Company and required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.
Changes in Internal ControlsSubsequent to the Evaluation Date, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls.
PART III
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and executive officers of the registrant is incorporated by reference and contained in the Proxy material on Page 1-3 and following.
Information concerning the Company’s Code of Ethics is incorporated by reference and contained in the Proxy material on Page 1-6.
EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference and contained in the Proxy material on Page 1-7.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of owners and management is incorporated by reference and contained in the Proxy material on Page 1-3 and following.
II-63
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions is incorporated by reference and contained in the Proxy material on Page 1-12.
PRINCIPAL ACCOUNTING FEES AND SERVICES
(Last Two Fiscal Years)
Information concerning principal accounting fees and services, as well as information concerning the Company’s audit committee pre-approval policies and procedures, is incorporated by reference and contained in the Proxy material on Page I-11.
PART IV
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K
Financial Statements and Exhibits
The following financial statements included under the heading “Financial Statements and Supplementary Data” are included in this report:
(a) Independent Auditors' Report (b) Consolidated Statements of Condition - December 31, 2003 and 2002 (c) Consolidated Statements of Income - Years Ended December 31, 2003, 2002 and 2001 (d) Consolidated Statements of Comprehensive Income -Years Ended December 31, 2003, 2002 and 2001 (e) Consolidated Statements of Stockholders' Equity -Years Ended December 31, 2003, 2002 and 2001 (f) Consolidated Statements of Cash Flows - Years Ended December 31, 2003, 2002 and 2001 Notes to (g) Consolidated Financial Statements
The following exhibits have been filed with the Securities and Exchange Commission and are available upon written request:
3 (A) Articles of Incorporation, as amended. Filed as Exhibit 3 to the Company’s Form S-1 (File No. 33-08751) September 15, 1986, incorporated herein by reference.
3 (B) Bylaws, as amended. Filed as Exhibit 3-b to the Company’s Form S-1 (File No. 33-08751) September 15, 1986, incorporated herein by reference.
21 Subsidiaries of the Company 23 Consent of Independent Auditors
The following Rule 13a-14(a)/15d-14(a) Certifications are included as exhibits to this report:
31 Rule 13a-14(a) Certification of Hugh S. Potts, Jr., Chief Executive Officer and Rule 13a-14(a) Certification of Robert C. Thompson, Treasurer
The following Section 1350 Certifications are included as exhibits to this report:
32 Section 1350 Certification of Hugh S. Potts, Jr., Chief Executive Officer and Section 1350 Certification of Robert C. Thompson, TreasurerReports on Form 8-K
Form 8-K filed on October 22, 2003 in connection with the Company’s earnings press release for the third quarter of 2003.
II-64
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST M & F CORPORATION
By: /s/ Hugh S. Potts, Jr. By: /s/ Robert C. Thompson, III
------------------------- ----------------------------
Hugh S. Potts, Jr. Robert C. Thompson, III
Chairman of the Board and Treasurer
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following
persons on behalf of the Registrant and in the capacities and on the dates indicated:
/s/ Hugh S. Potts, Jr.
DATE: March 9, 2004 --------------------------------
Hugh S. Potts, Jr., Director
/s/ Scott M. Wiggers
DATE: March 9, 2004 --------------------------------
Scott M. Wiggers, Director
/s/ Fred A. Bell, Jr.
DATE: March 9, 2004 --------------------------------
Fred A. Bell, Jr., Director
/s/ Jon A. Crocker
DATE: March 9, 2004 --------------------------------
Jon A. Crocker, Director
/s/ Charles T. England
DATE: March 9, 2004 --------------------------------
Charles T. England, Director
/s/ Toxey Hall, III
DATE: March 9, 2004 --------------------------------
Toxey Hall, III, Director
/s/ Barbara K. Hammond
DATE: March 9, 2004 --------------------------------
Barbara K. Hammond, Director
/s/ Charles V. Imbler, Sr.
DATE: March 9, 2004 --------------------------------
Charles V. Imbler, Sr., Director
/s/
DATE: March 9, 2004 --------------------------------
J. Marlin Ivey, Director
/s/ R. Dale McBride
DATE: March 9, 2004 --------------------------------
R. Dale McBride, Director
/s/ Susan P. McCaffery
DATE: March 9, 2004 --------------------------------
Susan P. McCaffery, Director
/s/ Otho E. Pettit, Jr.
DATE: March 9, 2004 --------------------------------
Otho E. Pettit, Jr., Director
II-65
/s/ Charles W. Ritter, Jr.
DATE: March 9, 2004 --------------------------------
Charles W. Ritter, Jr., Director
/s/ L. F. Sams, Jr.
DATE: March 9, 2004 --------------------------------
L. F. Sams, Jr., Director
/s/ Michael W. Sanders
DATE: March 9, 2004 --------------------------------
Michael W. Sanders, Director
/s/ W. C. Shoemaker
DATE: March 9, 2004 --------------------------------
W. C. Shoemaker, Director
/s/ James I. Tims
DATE: March 9, 2004 --------------------------------
James I. Tims, Director
/s/ Edward G. Woodard
DATE: March 9, 2004 --------------------------------
Edward G. Woodard, Director
II-66
EXHIBIT 31
CERTIFICATIONS
I, Hugh S. Potts, Jr., certify that:
1. I have reviewed this Annual Report on Form 10-K of First M & F Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-l5(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting
to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report
our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, 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 and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
the registrant's internal control over financial reporting.
/s/ Hugh S. Potts, Jr.
Date: March 9, 2004 ------------------------------------
Hugh S. Potts, Jr.
Chairman and Chief Executive Officer
II-67
I, Robert C. Thompson, III, certify that:
1. I have reviewed this Annual Report on Form 10-K of First M & F Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-I5(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting
to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report
our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred
during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an
annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, 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 and material weaknesses in the design or operation of internal control over
financial reporting which are reasonably likely to adversely affect registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
the registrant's internal control over financial reporting.
/s/ Robert C. Thompson, III
Date: March 9, 2004 -------------------------------
Robert C. Thompson, III
Treasurer
II-68
EXHIBIT 32
SECTION 1350 CERTIFICATIONS
In connection with the Annual Report of First M & F Corporation (the "Company") on Form 10-K for the period ended
December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Hugh S.
Potts, Jr., Chief Executive Officer of the Company, certify, to the best of my knowledge and belief, pursuant to 18
U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, that:
A. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
B. The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
Date: March 9, 2004
/s/ Hugh S. Potts, Jr.
-----------------------------------
Hugh S. Potts, Jr.
Chairman and Chief Executive Officer
In connection with the Annual Report of First M & F Corporation (the "Company") on Form 10-K for the period ended
December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert C.
Thompson, III, Treasurer of the Company, certify, to the best of my knowledge and belief, pursuant to 18 U.S.C. 1350, as
adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002, that:
C. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
D. The information contained in the Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
Date: March 9, 2004
/s/ Robert C. Thompson, III
------------------------------------
Robert C. Thompson, III
Treasurer
II-69
EXHIBIT INDEX
3 (A) Articles of Incorporation, as amended. Filed as Exhibit 3 to the Company's Form S-1 (File No. 33-0875 1) September
15, 1986, incorporated herein by reference.
3 (B) Bylaws, as amended. Filed as Exhibit 3-b to the Company's Form S-1 (File No. 33-08751) September 15, 1986,
incorporated herein by reference.
21 Subsidiaries of the Company
23 Consent of Independent Auditor
31 Rule 13a-14(a) Certification of Hugh S. Potts, Jr., Chief Executive Officer and Rule 13a-14(a) Certification of
Robert C. Thompson, Treasurer
32 Section 1350 Certification of Hugh S. Potts, Jr., Chief Executive Officer and Section 1350 Certification of
Robert C. Thompson, Treasurer