SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
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, 2002.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee required]
For the transition period from to
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Commission file number 33-66014
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FNB FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
COMMONWEALTH OF PENNSYLVANIA 23-2466821
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(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
101 Lincoln Way West, McConnellsburg, PA 17233
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 717-485-3123
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Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Class Outstanding as of March 15, 2003
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Common Stock, $0.315 Par Value 800,000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K [X].
The aggregate market value of the voting stock held by non-affiliates of the
registrants as of March 15, 2003:
Common Stock, $ 0.315 par value - $ 18,000,000
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the annual shareholders report for the year ended December 31,
2002, are incorporated by reference into Parts I, II and IV. Portions of the
proxy statement for the annual shareholders meeting to be held April 22, 2003,
are incorporated by reference into Part III.
Page 2 of 16
FNB FINANCIAL CORPORATION
FORM 10-K
INDEX
Page
Part I
Item 1. Business 2 - 10
Item 2. Properties 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 11
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 8. Financial Statements and Supplementary Data 11
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 11
Part III
Item 10. Directors and Executive Officers of the Registrant 11
Item 11. Executive Compensation 11
Item 12. Security Ownership of Certain Beneficial Owners
and Management 11
Item 13. Certain Relationships and Related Transactions 11
Item 14. Controls and Procedures 11 - 12
Part IV
Item 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 12 - 13
Signatures 14
Certification of Chief Executive Officer required by Form 10-K 15
Certification of Chief Financial Officer required by Form 10-K 16
Page 3 of 16
PART I
Item 1. Business
Description of Business
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FNB Financial Corporation (the Company), a Pennsylvania business corporation,
is a bank holding company registered with and supervised by the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board").
The Company was incorporated on June 22, 1987, under the business corporation
law of the Commonwealth of Pennsylvania for the purpose of becoming a bank
holding company. Since commencing operations, the Company's business has
consisted primarily of managing and supervising The First National Bank of
McConnellsburg (the Bank) and its principal source of income has been
dividends paid by the Bank. The Company has one wholly-owned subsidiary,
the Bank.
The Bank was established in 1906 as a national banking association under
the supervision of the Comptroller of the Currency, the Comptroller.
The Bank is a member of the Federal Reserve System and customers' deposits
held by the Bank are insured by the Federal Deposit Insurance Corporation
to the maximum extent permitted by law. The Bank is engaged in a full
service commercial and consumer banking business including the acceptance
of time and demand deposits and the making of secured and unsecured loans.
The Bank provides its services to individuals, corporations, partnerships,
associations, municipalities, and other governmental bodies. As of
December 31, 2002, the Bank had three (3) offices and (1) drive-up ATM located
in Fulton County, one (1) branch office facility located in Fort Loudon,
Franklin County Pennsylvania and one (1) branch office facility located in
Hancock, Washington County, Maryland. During 1995 the Bank received
regulatory approval from The Comptroller to purchase and assume the deposits,
real estate, and building of the Fort Loudon Branch Office of Dauphin Deposit
Bank located in Franklin County, Pennsylvania. Due to the location of this
office, management and the Board felt the acquisition of this office was
strategically important in order to officially expand the Bank's market area
into the Franklin County,PA area and diversify its current primary market of
Fulton County, PA. During 1996 the Bank received regulatory approval from
the Comptroller to open its first interstate Branch office in Hancock,
Maryland after management became aware of the closing of a branch office
of First Federal Savings Bank of Western Maryland. This office is known as
"Hancock Community Bank, A Division of The First National Bank of
McConnellsburg". The location of this office is felt to be strategically
important in order to expand the Bank's operations into Washington County,
Maryland and northern Morgan County, West Virginia. This office is also
the Bank's first supermarket branch office. In October 2000, the owner
of the adjacent supermarket completed extensive renovations at which time
the wall between the branch office and the supermarket was removed,
allowing customers to enter the branch directly from the supermarket.
The Bank received permission from the Comptroller to expand its main office
facilities in downtown McConnellsburg to allow for larger customer service,
loan department, and data processing areas. This expansion was completed on
September 1,1996, at a cost of approximately $1,700,000. In February 1999,
the Bank purchased an adjacent property to the main office facility at 115
Lincoln Way West in downtown McConnellsburg from the Fulton Overseas Veterans
Association. This site is 54' by 218' and has situated on it a three story
building comprised of 4,577 usable square feet on the first floor and a 28'
by 60' finished basement. The second and third stories of the building are not
usable. The Bank has no immediate plans for this facility but felt it was
a wise decision to purchase it for strategic planning purposes. The Bank
has one wholly-owned subsidiary, First Fulton County Community Development
Corporation, which is a Community Development Corporation formed under
12USC24/2CFR24 whose primary regulator is the Office of the Comptroller
of the Currency, The Comptroller. The First Fulton County Community
Development Corporation was incorporated with the Commonwealth of
Pennsylvania on May 30, 1995. The primary
Page 4 of 16
business of this community development corporation is to provide and promote
community welfare through the establishment and offering of low interest rate
loan programs to stimulate economic rehabilitation and development for the
Borough of McConnellsburg and the entire community of Fulton County, PA.
Competition
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Our primary market area includes all of Fulton County and portions of
Huntingdon, Bedford, and Franklin Counties, portions of Washington County,
Maryland and portions of Morgan County, West Virginia. Our major competitor
is a one bank holding company headquartered in McConnellsburg, Pennsylvania
which has 7 branches located throughout Fulton, Franklin, and Huntingdon
Counties. As of December 31, 2002, we were ranked second in total deposits
when compared to our major competitor. Also, in this market area we compete
with regionally-based commercial banks (all of which have greater assets,
capital, and lending limits), savings banks, savings and loan associations,
money market funds, insurance companies, stock brokerage firms, regulated
small loan companies, credit unions and with issuers of commercial paper
and other securities.
Although deregulation has allowed us to become more Competitive in the
market place in regard to pricing of loan and deposit rates, there are
disparities in taxing law which give some of our nonbank competitors
advantages which commercial banks do not enjoy and many burdensome
and costly regulations with which we must comply. We meet these
challenges by developing and promoting our locally-owned community
bank image; by offering friendly and professional customer service;
and by striving to maintain competitive interest rates for both loans
and deposits.
Regulation and Supervision
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FNB Financial Corporation (FNB) is a financial holding company,
and is registered as such with the Board of Governors of the
Federal Reserve System (the Federal Reserve Board). As a financial
holding company, the Corporation may engage in, and acquire companies
engaged in, activities that are considered "financial in nature",
as defined by the Gramm-Leach-Bliley Act and Federal Reserve Board
interpretations. These activities include, among other things,
securities underwriting, dealing and market-making, sponsoring
mutual funds and investment companies, insurance underwriting and
agency activities, and merchant banking. If any banking subsidiary
of the Corporation ceases to be "well capitalized" or "well managed"
under applicable regulatory standards, the Federal Reserve Board may,
among other things, place limitations on the Corporation's ability
to conduct the broader financial activities permissible for financial
holding companies or, if the deficiencies persist, require the
Corporation to divest the banking subsidiary. In addition, if
any banking subsidiary of the Corporation receives a Community
Reinvestment Act rating of less than satisfactory, the Corporation
would be prohibited from engaging in any additional activities
other than those permissible for bank holding companies that are
not financial holding companies. The Corporation may engage directly
or indirectly in activities considered financial in nature, either de
novo or by acquisition, as long as it gives the Federal Reserve board
after-the-fact notice of the new activities. The Gramm-Leach-Bliley Act
also permits national banks, such as The First National Bank of McConnellsburg,
to engage in activities considered financial in nature through a financial
subsidiary, subject to certain conditions and limitations and with the
approval of the OCC.
Interstate Banking and Branching. As the bank holding company,
the Corporation is required to obtain prior Federal Reserve Board
approval before acquiring more than 5% of the voting shares, or
substantially all of the assets, of a bank holding company, bank,
or savings association. Under the Riegle-Neal Interstate Banking
and Branching Efficiency Act (Riegle-Neal), subject to certain
concentration limits and other requirements, bank holding companies
such as the Corporation may acquire banks and bank holding companies
located in any state. Riegle-Neal also permits banks to acquire
branch offices outside their home states by merging with out-of-state
banks, purchasing branches in other states,
Page 5 of 16
and establishing de novo branch offices in other states. The ability of
banks to acquire branch offices is contingent, however, on the host state
having adopted legislation "opting in" to those provisions of Riegle-Neal.
In addition, the ability of a bank to merge with a bank located in another
state is contingent on the host state not having adopted legislation "opting
out" of that provision of Riegle-Neal.
Control Acquisitions. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company, unless the
Federal Reserve Board has been notified and has not objected to the transaction.
Under a rebuttable presumption established by the Federal Reserve Board, the
acquisition of 10% or more of a class of voting stock of a bank holding company
with a class of securities registered under Section 12 of the Exchange Act,
such as the Corporation, would, under the circumstances set forth in the
presumption,constitute acquisition of control of the bank holding company.
In addition, a company is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5%
in the case of an aquiror that is a bank holding company) or more of any
class of outstanding voting stock of a bank holding company, or otherwise
obtaining control or a "controlling influence" over that bank holding company.
Operations of the First National Bank of McConnellsburg are subject to federal
and state statutes applicable to banks chartered under the banking laws of the
United States, to members of the Federal Reserve System and to banks whose
deposits are insured by the FDIC. Our operations are also subject to
regulations of the Comptroller, the Federal Reserve Board, and the FDIC. Our
primary supervisory authority is the Comptroller, which regulates and examines
us. The Comptroller has authority to prevent national banks from engaging in
unsafe or unsound practices in conducting their businesses.
Legislation and Regulatory Changes
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From time to time, legislation is enacted which has the effect of increasing
the cost of doing business, limiting or expanding permissible activities or
affecting the competitive balance between banks and other financial
institutions. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial
institutions are frequently made in Congress, and before various bank
regulatory agencies. No prediction can be made as to the likelihood of any
major changes or the impact such changes might have on the Company and its
subsidiary, the Bank. Certain changes of potential significance to the
Company which have been enacted recently are discussed below.
The Federal Reserve Board, the FDIC, and the Comptroller have issued
risk-based capital guidelines, which supplement existing capital requirements.
The guidelines require all United States banks and bank holding companies to
maintain a minimum risk-based capital ratio of 8.0% (of which at least 3.0%
must be in the form of common stockholders' equity). Assets are assigned to
five risk categories, with higher levels of capital being required for the
categories perceived as representing greater risk. The required capital will
represent equity and (to the extent permitted) nonequity capital as a
percentage of total risk-weighted assets. On the basis of an analysis of the
rules and the projected composition of the Company's consolidated assets, it
is not expected these rules will have a material effect on the Company's
business and capital plans. The company presently has capital ratios exceeding
all regulatory requirements.
The Financial Institution Reform, Recovery and Enforcement Act of 1989
("FIRREA") was enacted in August 1989. This law was enacted primarily to
improve the supervision of savings associations by strengthening capital,
accounting, and other supervisory standards. In addition, FIRREA reorganized
the FDIC by creating two deposit insurance funds to be administered by the
FDIC: the Savings Association Insurance Fund and the Bank Insurance Fund.
Customers' deposits held by the Bank are insured under the Bank Insurance Fund.
FIRREA also regulated real estate appraisal standards and the
supervisory/enforcement powers and penalty provisions in connection with the
regulation of the Bank.
Page 6 of 16
In December 1991 the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA") became law. Under FDICIA, institutions must be classified,
based on their risk-based capital ratios into one of five defined categories
(well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized) as outlined below:
Total Tier 1 Under a
Risk- Risk- Tier 1 Capital
Based Based Leverage Order or
Ratio Ratio Ratio Directive
CAPITAL CATEGORY
Well capitalized >10.0% >6.0% >5.0% No
Adequately capitalized > 8.0% >4.0% >4.0%*
Undercapitalized
Significantly < 8.0% <4.0% <4.0%*
Undercapitalized < 6.0% <3.0% <3.0%
Critically
Undercapitalized <2.0%
*3.0% for those banks having the highest available regulatory rating.
Under FDICIA financial institutions are subject to increased regulatory
scrutiny and must comply with certain operational, managerial and
compensation standards to be developed by Federal Reserve Board Regulations.
FDICIA also required the regulators to issue new rules establishing certain
minimum standards to which an institution must adhere including standards
requiring a minimum ratio of classified assets to capital, minimum earnings
necessary to absorb losses and minimum ratio of market value to book value
for publicly held institutions
Annual full-scope, on-site examinations are required for all FDIC-insured
institutions except institutions with assets under $100 million which are
well capitalized, well managed and not subject to a recent change in control,
in which case, the examination period is every eighteen (18) months. FDICIA
also required banking agencies to reintroduce loan-to-value ("LTV") ratio
regulations which were previously repealed by the 1982 Act. LTV's will limit
the amount of money a financial institution may lend to a borrower, when the
loan is secured by real estate, to no more than a percentage to be set by
regulation of the value of the real estate.
A separate subtitle within FDICIA, called the "Bank Enterprise Act of 1991",
requires "truth-in-savings" on consumer deposit accounts so that consumers
can make meaningful comparisons between the competing claims of banks with
regard to deposit accounts and products. Under this provision which became
effective on June 21, 1993, the Bank is required to provide information to
depositors concerning the terms and fees of their deposit accounts and to
disclose the annual percentage yield on interest-bearing deposit accounts.
Federal regulators issued regulations to implement the privacy provisions of
the Gramm-Leach-Bliley Act (Financial Services Modernization Act). This new
law requires banks to notify consumers about their privacy policies and to
give them an opportunity to "opt-out" or prevent the bank from sharing
"nonpublic personal information" about them with nonaffiliated third parties.
Regulations became effective during 2001. We have developed privacy policies
and procedures to provide timely disclosure of such policies and a convenient
means for consumers to opt out of the sharing of their information with
unaffiliated third parties.
We do not anticipate compliance with environmental laws and regulations to
have any material effect on their respective capital, expenditures,
earnings, or competitive position.
Page 7 of 16
Employees
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As of December 31, 2002, we employed 52 persons on a full-time equivalent
basis.
Statistical Data
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Computation of our regulatory capital requirements for the periods
December 31, 2002 and December 31, 2001, on page 23 of the annual shareholders
report for the year ended December 31, 2002, is incorporated herein by
reference.
Loan Portfolio
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We make loans to both individual consumers and commercial entities. The types
offered include auto, personal, mortgage, home equity, school, home repair,
small business, commercial, and home construction loans. Within these loans
types, we make installment loans, which have set payments allowing the loan to
be amortized over a fixed number of payments; demand loans, which have no fixed
payment and which are payable in full on demand and are normally issued for a
term of less than one year; and mortgage loans, which are secured with
marketable real estate and have fixed payment amounts for a pre-established
payment period.
We do not assume undue risk on any loan within the loan portfolio, and take
appropriate steps to secure all loans as necessary.
We have adopted the following loan-to-value ratios, in accordance with
standards adopted by our bank supervisory agencies:
Loan Category Loan-to-Value Limit
Raw Land 65%
Land Development 75%
Construction:
Commercial, Multifamily, and
other Nonresidential 1 to 4
Family Residential 80%
Improved Property 85%
Owner-occupied 1 to 4 Family and
Home Equity 90%
We are neither dependent upon nor exposed to loan concentrations to a single
customer or to a single industry, the loss of any one or more of which would
have a material adverse effect on the financial condition of the Bank;
however, a portion of the Bank's customers' ability to honor their contracts
is dependent upon the construction and land development and agribusiness
economic sector. As a majority of our loan portfolio is comprised of loans to
individuals and businesses in Fulton County, Pennsylvania, a significant
portion of our customers' abilities to honor their contracts is dependent
upon the general economic conditions in, South Central Pennsylvania.
Loan Portfolio composition as of December 31, 2002 and December 31, 2001,
on page 14 of the annual shareholders report for the year ended December 31,
2002, is incorporated herein by reference.
Maturities of loans as of December 31, 2002, on page 14 of the annual
shareholders report for the year ended December 31, 2002, is incorporated
herein by reference. Nonperforming loans consist of nonaccruing loans and
loans 90 days or more past due. Nonaccruing loans are comprised of loans
that are no longer accruing interest income because of apparent financial
difficulties of the borrower. Interest on nonaccruing loans is recorded
when received only after past due principal and interest are brought current.
Our general policy is to classify loans as nonaccrual when they become past
due in principal and
Page 8 of 16
interest for over 90 days and collateral is insufficient to allow continuation
of interest accrual. At that time, the accrued interest on the nonaccrual loan
is reversed from the current year earnings and interest is not accrued until
the loan has been brought current in accordance with contractual terms.
Nonaccrual, Past Due and Restructured Loans as of December 31, 2002,
December 31, 2001, and December 31, 2000, on page 16 of the annual shareholders
report for the year ended December 31, 2002, are incorporated herein by
reference.
Allowance for Loan Loss Analysis
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The allowance for loan losses is maintained at a level to absorb potential
future loan losses contained in the loan portfolio and is formally reviewed
by us on a quarterly basis.
Management utilizes a comprehensive systematic review of our loan portfolio on
a quarterly basis in order to determine the adequacy of the Allowance for Loan
Losses. Each quarter the loan portfolio is categorized into various Pools as
follows:
POOL #1 Specific allowances for any individually identified
trouble loans
POOL #2 Commercial and Industrial
POOL #3 Commercial and Industrial - Real Estate Secured
POOL #4 Consumer Demand and Installment
POOL #5 Guaranteed Loans and Farmers and Commercial
POOL #6 Consumer Mortgage and Home Equity
POOL #7 Real Estate Secured - Farmland
Lines of credit and non-secured commercial loans with balances of $ 100,000
and over are individually reviewed. Also, loans that are 90 days or more past
due or have been previously classified as substandard are individually
reviewed. Allocations to the Allowance for Loan Losses are based upon
classifications assigned to those loans.
Loan classifications utilized are consistent with OCC regulatory guidelines and
are as follows:
Allowance Factors
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Loss Charge-off
Doubtful 20% - 50%
Substandard 10% - 20%
Special Mention 5% - 10%
Watch 1% - 5%
The remaining portion of the Pools are evaluated as groups with allocations
made to the allowance based on historical loss experience, current and
anticipated trends in delinquencies, and general economic conditions within
the bank's trading area.
In addition to the aforementioned internal loan review, the Bank engages an
outside firm to annually conduct an independent loan review in order to
validate the methodologies used internally and to independently test the
adequacy of the Allowance for Loan Losses.
The allowance is increased by provisions charged to operating expense and
reduced by net charge-offs. Our basis for the level of the allowance and
the annual provisions is our evaluation of the loan portfolio, current and
projected domestic economic conditions, the historical loan loss experience,
present and prospective financial condition of the borrowers, the level of
nonperforming assets, best and worst case scenarios of possible loan losses
and other relevant factors. While we use available information to make such
evaluations, future adjustments of the allowance may be necessary if economic
conditions differ substantially from the assumptions used in making the
evaluation. Loans are charged against the allowance for loan losses when
we believe that the collectibility of the principal is unlikely.
Page 9 of 16
Activity in the allowance for loan losses and a breakdown of the allowance
for loan losses as of December 31, 2002 and December 31, 2001, on page 15
and 16 of the annual shareholders report for the year ended December 31,
2002, are incorporated herein by reference.
Although loans secured by residential and non-residential mortgages comprise
approximately 69% of the entire loan portfolio, until recently these
mortgages have historically resulted in little or no loss. The allocation
of the Allowance for Loan Losses for these mortgages is based upon this
historical fact. Due to a more critical evaluation of our commercial,
industrial, and agricultural loan portfolio, the allocation of the Allowance
for Loan Losses for commercial, industrial, and agriculture loans has been set
accordingly.
Deposits
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Time Certificates of Deposit of $ 100,000 and over as of December 31, 2002
and December 31, 201, totaled $ 13,395,000 and $ 12,396,000, respectively.
Maturities and rate sensitivity of total interest bearing liabilities as of
December 31, 2002, on page 37 of the annual shareholders report for the year
ended December 31, 2002, is incorporated herein by reference.
Returns on Equity and Assets
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Returns on equity and assets and other statistical data for 2002, 2001, and
2000 on page 26 of the annual shareholders report for the year ended
December 31, 2002, is incorporated herein by reference.
Item 2. Properties
The physical properties where we conduct our business in the Commonwealth of
Pennsylvania are all owned by us while the property where we conduct business
in the State of Maryland is leased. The properties owned by us are as
follows: the main office located at 101 Lincoln Way West, McConnellsburg,
Pennsylvania, has been attached by a two story brick and frame addition,
to a building located at 111 South Second Street, McConnellsburg, Pennsylvania,
which houses the Bank's consumer loan department on the first floor and
commercial loan department and future expansion space on the second floor; a
property adjacent to the main office facility at 115 Lincoln Way West in
downtown McConnellsburg comprised of a 54' by 218' city lot which has situated
on it a three story building consisting of 4,577 usable square feet on the
first floor, a 28' by 60' finished basement, second and third stories which are
unusable and a detached garage; a branch office located on Route 522 South,
Needmore, Pennsylvania; a property located at Routes 16 and 30 East,
McConnellsburg, Pennsylvania, which contains a drive-up automatic teller
machine and a five (5) lane drive-up branch accessible from both Route 30
and Route 16; and a branch office located at 30 Mullen Street, Fort Loudon,
Pennsylvania, for which we received regulatory approval from the Office of
the Comptroller of the Currency to purchase effective November 13, 1995.
The branch office leased by us in the state of Maryland is located in the
Hancock Shopping Center at 343 North Pennsylvania Avenue in Hancock, Maryland
next to a supermarket.
Item 3. Legal Proceedings
In our opinion, there are no proceedings pending to which we are a party or
to which our property is subject, which, if determined adversely to us would
be material in relation to our retained earnings or financial condition.
There are no proceedings pending other than ordinary routine litigation
incident to our business. In addition, no material proceedings are known
to be threatened or contemplated against us by government authorities.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Page 10 of 16
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters
Our common stock is not traded on a national securities exchange but is traded
inactively in the over-the-counter market and is only occasionally and
sporadically traded through local and regional brokerage houses.
The Stock Market Analysis and Dividends for 2002 and 2001 on page 38 of the
annual shareholders report for the year ended December 31, 2002, is
incorporated herein by reference.
Item 6. Selected Financial Data
The Selected Five-Year Financial Data on page 26 of the annual shareholders
report for the year ended December 31, 2002, is incorporated herein by
reference.
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Management's discussion and analysis of financial condition and results of
operations on pages 31 through 38 of the annual shareholders report for the
year ended December 31, 2002, is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data, some of which is required
under Guide 3 (Statistical Disclosures by Bank Holding Companies) are shown
on pages 2 through 30 of the annual shareholders report for the year ended
December 31, 2002, are incorporated herein by reference.
The Summary of Quarterly Financial Data on page 27 of the annual shareholders
report for the year ended December 31, 2002, is incorporated herein by
reference.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
PART III
The information required by Items 10, 11, 12 and 13 is incorporated by
reference from FNB Financial Corporation's definitive proxy statement
for the 2003 Annual Meeting of Shareholders filed pursuant to Regulation 14A.
Item 14. Controls and Procedures
The Corporation's Chief Executive Officer and Chief Financial Officer have
evaluated the effectiveness of the Corporation's disclosure controls and
procedures (as such term is defined in Rules 13a-14(c) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act")) as of a date within
90 days prior to the filing date of this annual report (the "Evaluation Date").
Based on such evaluation, such officers have concluded that, as of the
Evaluation Date, the Corporation's disclosure controls and procedures are
effective in alerting them on a timely basis to material information
relating to the Corporation (including its consolidated subsidiaries)
required to be included in the Corporation's periodic filings under
the Exchange Act.
Page 11 of 16
Changes in Internal Controls
- ----------------------------
Since the Evaluation Date, there have not been any significant changes in the
Corporation's internal controls or in other factors that could significantly
affect such controls.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports of Form 8-K.
(a) (1) - List of Financial Statements
The following consolidated financial statements of FNB Financial
Corporation and its subsidiary, included in the annual report of
the registrant to its shareholders for the year ended December 31,
2002, are incorporated by reference in Item 8:
Consolidated balance sheets - December 31, 2002, and 2001
Consolidated statements of income - Years ended December 31, 2002,
2001, and 2000
Consolidated statements of stockholders' equity -Years ended
December 31, 2002, 2001, and 2000
Consolidated statements of cash flows - Years ended December 31,
2002, 2001, and 2000
Notes to consolidated financial statements - December 31, 2002
(2) - List of Financial Statement Schedules
Schedule I - Marketable Securities - Other Investments
Schedule III - Condensed Financial Information of
Registrant
Schedule VIII - Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.
(3) - Listing of Exhibits
Exhibit (3)(i) Articles of incorporation
Exhibit (3)(ii) Bylaws
Exhibit (4) Instruments defining the rights of
security holders including indentures
Exhibit (10) Material Contracts
Exhibit (13) Annual Report to Security holders
Exhibit (21) Subsidiaries of the registrant
Exhibit (99.1) Certification of Chief Executive Officer
pursuant 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
Exhibit (99.2) Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
All other exhibits for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.
Page 12 of 16
(b) Reports on Form 8-K filed
None.
(c) Exhibits
Exhibit (3)(i) Articles of incorporation - Exhibit 3A of Form SB-2
Registration Statement No. 33-66014 are incorporated herein by reference.
Exhibit (3)(ii) Bylaws - Exhibit 3B of Form SB-2 Registration Statement
No. 33-66014 are incorporated herein by reference.
Exhibit (4) Instruments defining the rights of security holders including
debentures - Document #1 of Form 10-K for FNB Financial Corporation for
fiscal year ended December 31, 1995 is incorporated herein by reference.
Exhibit (10.0) Executive Supplemental Retirement Plan for select officers -
incorporated by reference to the Company's Form 10-K for the year ended
December 31, 1999.
Exhibit (10.2) Director Fee Continuation Agreement for Select Directors -
incorporated by reference to the Company's Form 10-K for the year ended
December 31, 1999.
Exhibit (10.3) Executive Employment Contract for the President and CEO of
the Bank dated October 2000 is incorporated by reference to the Company's
Form 10-K for the year ended December 31, 2000.
Exhibit (13) Annual report to security holders - filed herewith.
Exhibit (21) Subsidiaries of the registrant - filed herewith.
Exhibit (99.1) Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 - filed herewith.
Exhibit (99.2) Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002 - filed herewith.
(d) Financial Statement Schedules
Schedule I - Marketable Securities - Other Investments Schedules of
Marketable Securities included on pages 12 and 13 of the annual report
of the registrant to its shareholders for the year ended December 31, 2002
are incorporated herein by reference.
Schedule III - Condensed Financial Information of Registrant
Condensed Financial Information of the Registrant included on page
20 - 22 of the annual report of the registrant to its shareholders for
the year ended December 31, 2002, is incorporated herein by reference.
Schedule VIII - Valuation and Qualifying Accounts
The schedule of the Allowance for Loan losses included on page 15 of the
annual report of the registrant to its shareholders for the year ended
December 31, 2002, is incorporated herein by reference.
Page 13 of 16
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.
FNB FINANCIAL CORPORATION
------------------------------
(Registrant)
/s/John C. Duffey 3/25/2003
------------------------------
John C. Duffey Date
President and Chief Executive Officer
(Principal Executive Officer)
/s/Dale M. Fleck 3/25/2003
------------------------------
Dale M. Fleck Date
Vice President, Controller &
Chief Financial Officer
(Principal Financial & Accounting
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/John C. Duffey 3/25/2003 /s/Harry D. Johnston 3/25/2003
- ---------------------------------- ------------------------------------
John C. Duffey Date Harry D. Johnston, D. O. Date
Director, President & CEO Director, Vice President
/s/Patricia A. Carbaugh 3/25/2003 /s/Lonnie W. Palmer 3/25/2003
- ---------------------------------- ------------------------------------
Patricia A. Carbaugh Date Lonnie W. Palmer Date
Director Director
/s/Harvey J. Culler 3/25/2003 /s/D.A. Washabaugh, III 3/25/2003
- ---------------------------------- ------------------------------------
Harvey J. Culler Date D. A. Washabaugh, III Date
Director, Chairman Director
/s/Paul T. Ott 3/25/2003 /s/Terry L. Randall 3/25/2003
- ---------------------------------- ------------------------------------
Paul T. Ott Date Terry L. Randall Date
Director Director
/s/Craig E. Paylor 3/25/2003
- ----------------------------------
Craig E. Paylor Date
Director
Page 14 of 16
CERTIFICATION
I, John C. Duffey, certify that:
1. I have reviewed this annual report on Form 10-K of FNB Financial
Corporation;
2. Based on my knowledge, the annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report.
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiary, is made known to us by others within
those entities, particularly during the period in which this
annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of the
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls.
6. The registrant's other certifying officer and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
the internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 25, 2003
----------------------------
By: /s/John C.Duffey
----------------------------
John C. Duffey
President and Chief
Executive Officer,
Director
Page 15 of 16
CERTIFICATION
I, Dale M. Fleck, certify, that:
1. I have reviewed this annual report on Form 10-K of FNB Financial
Corporation;
2. Based on my knowledge, the annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this annual report.
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report.
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiary, is made known to us by others within
those
entities, particularly during the period in which this annual
report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date.
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of the
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls.
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
the internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 25, 2003
----------------------------
By: /s/Dale M. Fleck
----------------------------
Dale M. Fleck
Vice President and Chief
Financial Officer,
(Principal Financial and
Accounting Officer)
Page 16 of 16
EXHIBIT 13
FNB FINANCIAL CORPORATION
2002 ANNUAL FINANCIAL REPORT
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS
Balance sheets 2
Statements of income 3
Statements of changes in stockholders' equity 4
Statements of cash flows 5 and 6
Notes to consolidated financial statements 7 - 25
ACCOMPANYING FINANCIAL INFORMATION
Selected five year financial data 26
Summary of quarterly financial data 27
Distribution of assets, liabilities and stockholders'
equity, interest rates, and interest differential 28
Changes in net interest income 29
Maturities of investment securities 30
Management's discussion and analysis of financial condition and
results of operations 31 - 39
INDEPENDENT AUDITOR'S REPORT
Board of Directors
FNB Financial Corporation
McConnellsburg, Pennsylvania
We have audited the accompanying consolidated balance sheets of FNB
Financial Corporation and its wholly-woned subsidiary as of December 31, 2002
and 2001, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years ended
December 31, 2002. These consolidated financial statements are the
responsibility of the Corporation's management. Our responsibility is
to express an opinion on these consolidated financial statements based on
our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States of America. Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated financial statements. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
FNB Financial Corporation and its wholly-owned subsidiary as of December 31,
2002 and 2001 and the results of their operations and their cash flows for
each of the three years ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States of America.
/S/Smith Elliott Kearns & Company, LLC
--------------------------------------
Chambersburg, Pennsylvania
February 14, 2003
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
2002 2001
ASSETS
Cash and due from banks $ 3,650,351 $ 5,400,929
Federal funds sold 0 6,000,000
Interest-bearing deposits with banks 968,266 2,572,574
Investment securities:
Available for sale 20,583,684 19,554,290
Held to maturity (fair value $692,188 -
2002; $ 1,088,460 - 2001) 692,839 1,114,764
Federal Reserve, Atlantic Central Banker's
Bank and Federal Home Loan Bank stock 666,000 833,700
Loans, net of unearned discount and allowance
for loan losses 100,526,867 90,167,678
Bank building, equipment, furniture
and fixtures, net 2,723,375 2,914,416
Accrued interest and dividends receivable 658,856 619,464
Deferred income taxes 51,703 160,529
Other real estate owned 66,512 103,568
Cash surrender value of life insurance 2,405,020 2,313,129
Other assets 371,932 405,475
------------- -------------
Total assets $ 133,365,405 $ 132,160,516
============= =============
LIABILITIES
Deposits:
Demand deposits $ 13,930,687 $ 13,343,930
Savings deposits 30,520,623 32,659,787
Time certificates 65,934,931 65,647,473
Other time deposits 306,118 311,190
------------- -------------
Total deposits 110,692,359 111,962,380
Liability for borrowed funds 7,232,659 5,403,458
Accrued dividends payable 264,000 216,000
Accrued interest payable and
other liabilities 999,564 1,190,681
------------- -------------
Total liabilities 119,188,582 118,772,519
------------- -------------
STOCKHOLDERS' EQUITY
Capital stock, common, par value $ .315;
12,000,000 shares authorized; 800,000
shares issued and outstanding 252,000 252,000
Additional paid-in capital 1,789,833 1,789,833
Retained earnings 11,746,170 11,124,857
Accumulated other comprehensive income 388,820 221,307
------------- -------------
Total stockholders' equity 14,176,823 13,387,997
------------- -------------
Total liabilities and
stockholders' equity $ 133,365,405 $ 132,160,516
============= =============
The Notes to Consolidated Financial Statements
are an integral part of these statements.
- 2 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2002, 2001, and 2000
2002 2001 2000
Interest and Dividend Income
Interest and fees on loans $7,292,537 $7,140,997 $6,902,812
Interest on investment securities:
Obligations of other U.S. Government
agencies 509,073 845,914 1,296,141
Obligations of States and political
subdivisions 402,302 416,998 421,345
Dividends on equity securities 25,519 59,123 61,901
Interest on deposits with banks 54,609 39,117 49,664
Interest on federal funds sold 68,424 265,496 22,725
---------- ---------- ----------
8,352,464 8,767,645 8,754,588
Interest Expense
Interest on borrowed funds 335,318 333,299 455,828
Interest on deposits 3,388,181 4,343,347 4,240,673
---------- ---------- ----------
Net interest income 4,628,965 4,090,999 4,058,087
Provision for Loan Losses 142,000 144,000 231,319
---------- ---------- ----------
Net interest income after provision
for loan losses 4,486,965 3,946,999 3,826,768
---------- ---------- ----------
Other Income
Service charges on deposit accounts 200,470 217,431 181,902
Other service charges, collection and
exchange charges, commissions and fees 305,406 366,337 283,232
Other income, net 143,217 137,375 159,272
Securities gains (losses) 44,776 17,986 (474)
---------- ---------- ----------
693,869 739,129 623,932
---------- ---------- ----------
Other Expenses
Salaries and wages 1,428,559 1,432,292 1,341,280
Pensions and other employee benefits 378,011 363,253 355,250
Net occupancy expense of bank premises 250,214 256,186 252,023
Furniture and equipment expenses 257,403 284,372 269,592
Other operating expenses 1,179,918 1,089,383 1,048,825
---------- ---------- ----------
3,494,105 3,425,486 3,266,970
---------- ---------- ----------
Income before income taxes 1,686,729 1,260,642 1,183,730
---------- ---------- ----------
Applicable income taxes 473,416 255,511 229,149
---------- ---------- ----------
Net income $1,213,313 $1,005,131 $954,581
Earnings per share of common stock:
Net income $1.52 $1.26 $1.19
Weighted average shares outstanding 800,000 800,000 800,000
The Notes to Consolidated Financial Statements
are an integral part of these statements.
- 3 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2002, 2001, and 2000
Accumulated
Additional Other Total
Common Paid-in Retained Comprehensive Stockholders'
Stock Capital Earnings Income (Loss) Equity
Balance, December 31, 1999 $ 252,000 $ 1,789,833 $ 10,125,145 ($ 966,241) $ 11,200,737
Comprehensive income:
Net income 0 0 954,581 0 954,581
Changes in unrealized gain
on securities available for
sale, net of taxes of
$ 437,213 0 0 0 848,709 848,709
------------
Total comprehensive income 1,803,290
------------
Cash dividends declared on
common stock ($ .57
per share) 0 0 (456,000) 0 (456,000)
--------- ----------- ------------ --------- -------------
Balance, December 31, 2000 252,000 1,789,833 10,623,726 (117,532) 12,548,027
Comprehensive income:
Net income 0 0 1,005,131 0 1,005,131
Changes in unrealized gain
on securities available for
sale, net of taxes of
$ 174,553 0 0 0 338,839 338,839
------------
Total comprehensive income 1,343,970
------------
Cash dividends declared on
common stock ($ .63
per share) 0 0 (504,000) 0 (504,000)
--------- ----------- ------------ --------- -------------
Balance, December 31, 2001 252,000 1,789,833 11,124,857 221,307 13,387,997
Comprehensive income:
Net income 0 0 1,213,313 0 1,213,313
Changes in unrealized gain
on securities available for
sale, net of taxes of
$ 86,293 0 0 0 167,513 167,513
------------
Total comprehensive income 1,380,826
------------
Cash dividends declared on
common stock ($ .74
per share) 0 0 (592,000) 0 (592,000)
--------- ----------- ------------ --------- -------------
Balance, December 31, 2002 $252,000 $1,789,833 $11,746,170 $388,820 $14,176,823
========= =========== ============ ========= =============
The Notes to Consolidated Financial Statements
are an integral part of these statements.
- 4 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001, and 2000
2002 2001 2000
Cash flows from operating activities:
Net income $ 1,213,313 $ 1,005,131 $ 954,581
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 260,581 300,331 288,168
Provision for loan losses 142,000 144,000 231,319
Deferred income taxes 22,532 (43,758) (52,037)
(Gain) loss on sale of other real estate (15,673) 19,038 805
Increase in cash surrender value of life insurance (91,891) (103,214) (102,811)
(Gain) loss on sales/maturities of investments (44,776) (17,986) 474
(Gain) loss on disposal of equipment 0 0 (865)
(Increase) decrease in accrued interest receivable (39,392) 169,929 (102,134)
Increase (decrease) in accrued interest
payable and other liabilities (191,117) 113,862 215,305
(Increase) decrease in other assets 33,543 (43,445) (84,490)
------------ ----------- ---------
Net cash provided by operating activities 1,289,120 1,543,888 1,348,315
------------ ----------- ---------
Cash flows from investing activities:
Net (increase) decrease in interest bearing
deposits with banks 1,604,308 (1,794,028) (55,453)
Maturities of held-to-maturity securities 421,925 93,071 461,877
Proceeds from sales of available-for-sale securities 942,253 38,720 0
Maturities of available-for-sale securities 3,840,642 10,107,008 2,742,252
Purchases of available-for-sale securities (5,513,706) (2,400,118) (140,076)
Proceeds from sales of other real estate owned 119,241 46,047 274,087
Net (increase) in loans (10,567,701) (7,199,505) (7,480,801)
Sale (purchase) of other bank stock 167,700 0 (152,500)
Purchases of bank premises and equipment, net (69,540) (131,082) (222,058)
Proceeds from sale of equipment 0 0 1,206
------------ ----------- ---------
Net cash (used) by investing activities (9,054,878) (1,239,887) (4,571,466)
------------ ----------- ---------
Cash flows from financing activities:
Net increase (decrease) in deposits (1,270,021) 8,329,892 4,302,552
Cash dividends paid (544,000) (480,000) (436,000)
Net short-term borrowings 1,835,000 0 (2,933,000)
Proceeds from long-term borrowings 0 0 12,250,000
Principal payments on long-term borrowings (5,799) (773,443) (9,505,095)
------------ ----------- ---------
Net cash provided by financing activities $15,180 $7,076,449 $3,678,457
============ =========== =========
The Notes to Consolidated Financial Statements
are an integral part of these statements.
- 5 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended December 31, 2002, 2001, and 2000
2002 2001 2000
Net increase (decrease) in cash and cash equivalents ($ 7,750,578) $ 7,380,450 $ 455,306
Cash and cash equivalents, beginning balance 11,400,929 4,020,479 3,565,173
----------- ----------- ----------
Cash and cash equivalents, ending balance $ 3,650,351 $ 11,400,929 $ 4,020,479
=========== =========== ==========
Supplemental disclosure of cash flows information:
Cash paid during the year for:
Interest $ 3,874,078 $ 4,766,560 $ 4,610,819
Income taxes 321,247 345,860 167,419
Supplemental schedule of noncash investing and
financing activities:
Unrealized gain on securities
available-for-sale, net of income tax effect $ 167,513 $ 338,839 $ 848,709
Other real estate acquired in settlement of loans 66,512 0 274,389
The Notes to Consolidated Financial Statements
are an integral part of these statements.
- 6 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Nature of Operations
- --------------------
FNB Financial Corporation's primary activity consists of owning and supervising
its subsidiary, The First National Bank of McConnellsburg, which is engaged in
providing banking and bank related services in South Central Pennsylvania, and
Northwestern Maryland. Its five offices are located in McConnellsburg (2),
Fort Loudon and Needmore, Pennsylvania, and Hancock, Maryland.
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of the Corporation
and its wholly-owned subsidiary, The First National Bank of McConnellsburg.
All significant intercompany transactions and accounts have been eliminated.
First Fulton County Community Development Corporation (FFCCDC) was formed as a
wholly-owned subsidiary of The First National Bank of McConnellsburg. The
purpose of FFCCDC is to serve the needs of low-to-moderate income individuals
and small business in Fulton County under the Community Development and
Regulatory Improvement Act of 1995.
Basis of Accounting
- -------------------
The Corporation uses the accrual basis of accounting.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowances
for losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
While management uses available information to recognize losses on loans and
foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions. In addition, regulatory
agencies, as an integral part of their examination process, periodically
review the Corporation's allowance for losses on loans and foreclosed real
estate. Such agencies may require the Corporation to recognize additions to
the allowance based on their judgments about information available to them at
the time of their examination. Because of these factors, management's estimate
of credit losses inherent in the loan portfolio and the related allowance may
change in the near term.
- 7 -
Note 1. Significant Accounting Policies (Continued)
Cash Flows
- ----------
For purposes of the statements of cash flows, the Corporation has defined cash
and cash equivalents as those amounts included in the balance sheet captions
"Cash and Due From Banks" and "Federal Funds Sold". As permitted by Statement
of Financial Accounting Standards No. 104, the Corporation has elected to
present the net increase or decrease in deposits in banks, loans and deposits
in the Statements of Cash Flows.
Investment Securities
- ---------------------
The Corporation's investments in securities are classified in three categories
and accounted for as follows:
* Trading Securities. Securities held principally for resale in the near term
are classified as trading securities and recorded at their fair values.
Unrealized gains and losses on trading securities are included in other income.
* Securities to be Held to Maturity. Bonds and notes for which the
Corporation has the positive intent and ability to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of
discounts which are recognized in interest income using the interest method
over the period to maturity.
* Securities Available for Sale. Securities available for sale consist of
equity securities, and bonds and notes not classified as trading securities nor
as securities to be held to maturity. These are securities that management
intends to use as a part of its asset and liability management strategy and may
be sold in response to changes in interest rates, resultant prepayment risk and
other related factors. Unrealized holding gains and losses, net of tax, on
securities available for sale are reported as a net amount in other
comprehensive income until realized. Gains and losses on the sale of securities
available for sale are determined using the specific-identification method.
Fair values for investment securities are based on quoted market prices.
The Corporation had no trading securities in 2002 or 2001.
Federal Reserve Bank, Atlantic Central Banker's Bank, and
Federal Home Loan Bank Stock
- ---------------------------------------------------------
These investments are carried at cost. The Corporation is required to
maintain minimum investment balances in these stocks, which are not
actively traded and therefore have no readily determinable market value.
Other Real Estate Owned
- -----------------------
Real estate properties acquired through, or in lieu of, loan foreclosure
are to be sold and are initially recorded at the lower of carrying value
or fair value of the underlying collateral less estimated cost to sell.
After foreclosure, valuations are periodically performed by management and
the real estate is carried at the lower of carrying amount or fair value
less estimated cost to sell. Legal fees and other costs related to
foreclosure proceedings are expensed as they are incurred.
- 8 -
Note 1. Significant Accounting Policies (Continued)
Loans and Allowance for Possible Loan Losses
- --------------------------------------------
Loans are stated at the amount of unpaid principal, reduced by unearned
discount, deferred loan origination fees, and an allowance for loan losses.
Unearned discount on installment loans is recognized as income over the terms
of the loans by the interest method. Interest on other loans is calculated by
using the simple interest method on daily balances of the principal amount
outstanding. Amortization of premiums and accretion of discounts on acquired
loans are recognized in interest income using the interest method over the
period to maturity. The allowance for loan losses is established through a
provision for loan losses charged to expense. Loans are charged against the
allowance for loan losses when management believes that the collectibility of
the principal is unlikely. The allowance is an amount that management believes
will be adequate to absorb possible losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of loans and prior
loan loss experience. The evaluations take into consideration such factors as
changes in the nature and volume of the loan portfolio, overall portfolio
quality, review of specific problem loans, and current economic conditions that
may affect the borrowers' ability to pay. Loan origination fees and certain
direct loan origination costs are being deferred and the net amount amortized
as an adjustment of the related loan's yield. The Corporation is amortizing
these amounts over the contractual life of the related loans.
Nonaccrual/Impaired Loans
- -------------------------
The accrual of interest income on loans ceases when principal or interest is
past due 90 days or more and collateral is inadequate to cover principal and
interest or immediately if, in the opinion of management, full collection is
unlikely. Interest accrued but not collected as of the date of placement on
nonaccrual status is reversed and charged against current income unless fully
collateralized. Subsequent payments received either are applied to the
outstanding principal balance or recorded as interest income, depending on
management's assessment of the ultimate collectibility of principal.
A loan is considered impaired when, based on current information and events,
it is probable that scheduled collections of principal or interest will not be
made according to the contractual terms of the loan agreement. Impairment is
measured on a loan-by-loan basis (except for consumer loans, which are
collectively evaluated) by either the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's obtainable
market price, or the fair value of the underlying collateral.
Interest income generally is not recognized on specific impaired loans unless
the likelihood of further loss is remote. Interest payments received on such
loans are applied as a reduction of the loan principal balance. Interest
income on other impaired loans is recognized only to the extent of interest
payments received.
Bank Building, Equipment, Furniture and Fixtures and Depreciation
- -----------------------------------------------------------------
Bank building, equipment, furniture and fixtures are carried at cost less
accumulated depreciation. Expenditures for replacements are capitalized and the
replaced items are retired. Maintenance and repairs are charged to operations
as incurred. Depreciation is computed based on straight-line and accelerated
methods over the estimated useful lives of the related assets as follows:
Years
Bank building 15-40
Equipment, furniture and fixtures 3-20
Land improvements 10-20
Leasehold improvements 7-20
- 9 -
Note 1. Significant Accounting Policies (Continued)
Earnings Per Share
- ------------------
Earnings per common share were computed based upon weighted average shares of
common stock outstanding of 800,000 for 2002, 2001, and 2000 after giving
retroactive recognition to a two-for-one stock split issued September 1, 2000.
Intangibles
- -----------
Identifiable intangible assets are amortized on a straight-line basis over
fifteen years.
Federal Income Taxes
- --------------------
As a result of certain timing differences between financial statement and
federal income tax reporting, deferred income taxes are provided in the
financial statements. See Note 7 for further details.
Advertising
- -----------
The Corporation follows the policy of charging costs of advertising to expense
as incurred. Advertising expense was $ 52,267, $ 80,238, and $ 98,561 for
2002, 2001, and 2000, respectively.
Fair Values of Financial Instruments
- ------------------------------------
Generally accepted accounting principles requires disclosure of fair value
information about financial instruments, whether or not recognized in the
balance sheet. In cases where quoted market prices are not available, fair
values are based on estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions
used, including the discount rate and estimates of future cash flows. In that
regard, the derived fair value estimates cannot be substantiated by comparison
to independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Certain financial instruments and all
nonfinancial instruments are excluded from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not represent the
underlying value of the Corporation.
The following methods and assumptions were used by the Corporation in
estimating fair values of financial instruments as disclosed herein:
* Cash and Short-Term Instruments. The carrying amounts of cash and short-
term instruments approximate their fair value.
* Securities to be Held to Maturity and Securities Available for Sale. Fair
values for investment securities are based on quoted market prices.
* Loans Receivable. For variable-rate loans that reprice frequently and have
no significant change in credit risk, fair values are based on carrying
values. Fair values for fixed rate loans are estimated using discounted cash
flow analyses, using interest rates currently being offered for loans with
similar terms to borrowers of similar credit quality. Fair values for
impaired loans are estimated using discounted cash flow analyses or underlying
collateral values, where applicable.
- 10 -
Note 1. Significant Accounting Policies (Continued)
* Deposit Liabilities. The fair values disclosed for demand deposits are, by
definition, equal to the amount payable on demand at the reporting date (that
is, their carrying amounts). The carrying amounts of variable-rate
certificates of deposit, and fixed-term money market accounts approximate their
fair values at the reporting date. Fair values for fixed-rate certificates of
deposit and IRA's are estimated using a discounted cash flow calculation that
applies interest rates currently being offered to a schedule of aggregated
expected monthly maturities on time deposits.
* Short-Term Borrowings. The carrying amounts of federal funds purchased,
borrowings under repurchase agreements, and other short-term borrowings
maturing within 90 days approximate their fair values. Fair values of other
short-term borrowings are estimated using discounted cash flow analyses based
on the Corporation's current incremental borrowing rates for similar types of
borrowing arrangements.
* Long-Term Borrowings. The fair value of the Corporation's long-term debt is
estimated using a discounted cash flow analysis based on the Corporation's
current incremental borrowing rate for similar types of borrowing arrangements.
* Accrued Interest. The carrying amounts of accrued interest approximate
their fair values.
* Off-Balance-Sheet Instruments. The Corporation generally does not charge
commitment fees. Fees for standby letters of credit and other off-balance-
sheet instruments are not significant.
Comprehensive Income
- --------------------
Under generally accepted accounting principles, comprehensive income is
defined as the change in equity from transactions and other events from
nonowner sources. It includes all changes in equity except those resulting
from investments by stockholders and distributions to stockholders.
Comprehensive income includes net income and certain elements of "other
comprehensive income" such as foreign currency transactions; accounting for
futures contracts; employers accounting for pensions; and accounting for
certain investments in debt and equity securities.
The Corporation has elected to report its comprehensive income in the
statement of stockholders' equity. The only element of "other comprehensive
income" that the Corporation has is the unrealized gain or loss on available
for sale securities.
The components of the change in net unrealized gains (losses) on securities
were as follows:
2002 2001 2000
Gross unrealized holding gains (losses)
arising during the year $ 298,582 $ 531,378 $ 1,285,448
Reclassification adjustment for
(gains)/losses realized in
net income ( 44,776) ( 17,986) 474
Net unrealized holding gains (losses)
before taxes 253,806 513,392 1,285,922
Tax effect ( 86,293) ( 174,553)( 437,213)
--------- --------- ----------
Net change $ 167,513 $ 338,839 $ 848,709
========= ========= ==========
- 11 -
Note 2. Investment Securities
The amortized cost and fair values of investment securities available for
sale at December 31 were:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2002
Obligations of other U.S.
Government agencies $ 5,597,609 $ 170,358 $ 0 $ 5,767,967
Obligations of states and
political subdivisions 8,315,356 368,502 0 8,683,858
Mortgage-backed securities 5,472,039 51,219 0 5,523,258
SBA Loan Pool certificates 509,858 3,175 ( 1,278) 511,755
Equities in local bank stock 99,701 8,645 ( 11,500) 96,846
-------------- --------------- --------------- --------------
Totals $ 19,994,563 $ 601,899 ($ 12,778) $ 20,583,684
============== =============== =============== ==============
2001
Obligations of other U.S.
Government agencies $ 7,838,868 $ 214,912 ($ 2,034) $ 8,051,746
Obligations of states and
political subdivisions 9,844,481 165,522 ( 52,136) 9,957,867
Mortgage-backed securities 693,173 3,509 ( 539) 696,143
SBA Loan Pool certificates 663,184 2,704 ( 2,356) 663,532
Equities in local bank stock 179,271 18,231 ( 12,500) 185,002
-------------- --------------- --------------- --------------
Totals $ 19,218,977 $ 404,878 ($ 69,565) $ 19,554,290
============== =============== =============== ==============
The amortized cost and fair values of investment securities held to maturity
at December 31 were:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2002
SBA loan pool certificates $ 427,220 $ 1,857 ($ 3,221) $ 425,856
Obligations of other U.S.
government agencies 265,619 713 0 266,332
------------ ------------- ------------ -------------
Totals $ 692,839 $ 2,570 ($ 3,221) $ 692,188
============ ============= ============ =============
2001
SBA loan pool certificates $ 551,033 $ 2,255 ($ 3,111) $ 550,177
Obligations of other U.S.
government agencies 563,731 0 ( 25,448) 538,283
------------ ------------- ------------ -------------
Totals $ 1,114,764 $ 2,255 ($ 28,559) $ 1,088,460
============ ============= ============ =============
- 12 -
Note 2. Investment Securities (Continued)
The amortized cost and fair values of investment securities available for
sale and held to maturity at December 31, 2002 by contractual maturity, are
shown below. Contractual maturities will differ from expected maturities
because borrowers may have the right to call or repay obligations with or
without call or repayment penalties.
Securities Available Securities Held
- - - - - - for Sale - - - - - - - - - - - - to Maturity- - - - - -
Amortized Fair Amortized Fair
Cost Value Cost Value
Due in one year or less $ 4,394,896 $ 4,470,546 $ 0 $ 0
Due after one year through
five years 7,377,542 7,753,008 0 0
Due after five years through
ten years 1,671,345 1,750,234 0 0
Due after ten years 469,182 478,037 265,619 266,332
-------------- -------------- ---------------- --------------
13,912,965 14,451,825 265,619 266,332
Mortgage-backed securities 5,472,039 5,523,258 0 0
SBA loan pool certificates 509,858 511,755 427,220 425,856
Equities in local bank stock 99,701 96,846 0 0
-------------- -------------- ---------------- --------------
Totals $ 19,994,563 $ 20,583,684 $ 692,839 $ 692,188
============== ============== ================ ==============
Proceeds from sales of investment securities available for sale during 2002
were $ 942,253. Gross losses on these sales were $ 3,156 and gross gains
were $ 47,932. Related taxes were $ 15,224.
Proceeds from sales of investment securities available for sale during 2001
were $ 38,720. Gross losses on these sales were $ 0 and gross gains were
$ 7,843. Related taxes were $ 2,667.
There were no sales of investment securities available for sale during 2000.
There were no sales of investment securities held-to-maturity in 2002, 2001,
or 2000.
Investment securities carried at $ 4,459,332 and $ 5,828,486 at December 31,
2002 and 2001, respectively, were pledged to secure public funds and for
other purposes as required or permitted by law.
- 13 -
Note 3. Loans
Loans consist of the following at December 31:
2002 2001
(000 omitted)
Real estate loans:
Construction and land development $ 3,679 $ 3,946
Secured by farmland 4,453 5,216
Secured by 1-4 family residential properties 52,668 43,945
Secured by multi-family residential properties 1,781 538
Secured by nonfarmland nonresidential properties 15,537 14,360
Loans to farmers (except loans secured
primarily by real estate) 3,237 3,314
Commercial, industrial and state and political
subdivision loans 10,690 10,392
Loans to individuals for household, family, or
other personal expenditures 7,457 7,848
All other loans 2,099 1,812
--------------- ---------------
Total loans 101,601 91,371
Less: Unearned discount on loans 146 321
Allowance for loan losses 928 882
--------------- ---------------
Net Loans $ 100,527 $ 90,168
=============== ===============
The following table shows maturities and sensitivities of loans to changes in
interest rates based upon contractual maturities and terms as of December 31,
2002.
Due Over
1 But
(000 omitted) Due Within Within 5 Due Over Nonaccruing
1 Year Years 5 Years Loans Total
Loans at pre-determined
interest rates $ 1,700 $ 10,154 $ 28,744 $ 149 $ 40,747
Loans at floating or
adjustable interest rates 13,205 2,775 44,088 786 60,854
Total (1) $ 14,905 $ 12,929 $ 72,832 $ 935 $ 101,601
(1) These amounts have not been reduced by the allowance for possible loan
losses or unearned discount.
The Corporation has granted loans to its officers and directors, and to their
associates. Related party loans are made on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with unrelated persons and do not involve more than
normal risk of collectibility. The aggregate dollar amount of these loans
was $ 1,121,995 and $ 1,139,616 at December 31, 2002 and 2001, respectively.
During 2002, $ 1,083,329 of new loans were made and repayments totaled
$ 1,100,950. During 2001, $ 2,362,817 of new loans were made and repayments
totaled $ 2,835,935.
Outstanding loans to Corporate employees totaled $ 1,326,593 and $ 1,289,035
at December 31, 2002 and 2001, respectively.
- 14 -
Note 4. Allowance for Loan Losses
Activity in the allowance for loan losses is summarized as follows:
2002 2001 2000
Allowance for loan losses, beginning of the year $ 882 $ 811 $ 746
Loans charged-off during the year:
Real estate mortgages 39 18 89
Installment loans 88 90 90
Commercial and all other loans 0 1 24
-------- -------- --------
Total charge-offs 127 109 203
Recoveries of loans previously charged-off:
Real estate mortgages 9 18 12
Installment loans 22 18 24
Commercial and all other loans 0 0 1
-------- -------- --------
Total recoveries 31 36 37
Net loans charged-off (recovered) 96 73 166
Provision for loan losses charged to
operations 142 144 231
-------- -------- --------
Allowance for loan losses, end of the year $ 928 $ 882 $ 811
======== ======== ========
Ratio of net charge-offs to average loans 0.10% 0.08% 0.20%
======== ======== ========
A breakdown of the allowance for loan losses as of December 31 is as follows:
- - - - - - - 2002 - - - - - - - - - - - - - 2001 - - - - - - -
Percent of Percent of
Loans in Loans in
Allowance Each Allowance Each
(000 omitted) Amount Category Amount Category
Commercial, industrial
and agriculture loans $ 645 21.71% $ 644 25.03%
1-4 family residential
mortgages 179 68.88% 131 64.40%
Consumer and
installment loan 55 9.41% 58 10.57%
Unallocated 49 N/A 49 N/A
--------- ------- --------- -------
Total $ 928 100.00% $ 882 100.00%
========= ======= ========= =======
- 15 -
Note 4. Allowance for Loan Losses (Continued)
Impairment of loans having a recorded investment of $ 803,043, $ 859,974 and
$ 1,228,633 at December 31, 2002, 2001, and 2000 respectively, was recognized
in conformity with generally accepted accounting principles. The average
recorded investment in impaired loans was $ 828,615, $ 1,019,975, and
$ 1,272,272 during 2002, 2001, and 2000, respectively. The total allowance
for loan losses related to these loans was $ 241,000 at December 31, 2002 and
$ 120,000 at both December 31, 2001 and 2000. Interest income on impaired
loans of $ 77,330, $ 85,042, and $ 118,811 was recognized for cash payments
received in 2002, 2001, and 2000, respectively.
Note 5. Nonaccrual, Past Due and Restructured Loans
The following table shows the principal balances of nonaccrual loans as of
December 31:
2002 2001 2000
Nonaccrual loans $ 934,673 $ 491,659 $ 323,337
========= ========= =========
Interest income that would have been
accrued at original contract rates $ 85,292 $ 43,468 $ 31,633
Amount recognized as interest
Income 56,361 28,545 22,933
--------- --------- ---------
Foregone revenue $ 28,931 $ 14,923 $ 8,700
========= ========= =========
Loans 90 days or more past due (still accruing interest) were as follows
at December 31:
2002 2001 2000
(000 omitted)
Real estate mortgages $ 91 $ 228 $ 30
Installment loans 47 45 112
Commercial and industrial 53 0 41
--------- --------- ---------
Total $ 191 $ 273 $ 183
========= ========= =========
Note 6. Bank Building, Equipment, Furniture and Fixtures
Bank building, equipment, furniture and fixtures consisted
of the following at December 31:
Accumulated Depreciated
Description Cost Depreciation Cost
2002
Land $ 231,635 $ 0 $ 231,635
Bank building and improvements 3,287,975 1,311,784 1,976,191
Equipment, furniture and fixtures 2,464,010 1,992,824 471,186
Leasehold improvements 64,028 19,665 44,363
---------------- ---------------- ----------------
$ 6,047,648 $ 3,324,273 $ 2,723,375
================ ================ ================
2001
Land $ 231,635 $ 0 $ 231,635
Bank building and improvements 3,282,293 1,220,619 2,061,674
Equipment, furniture and fixtures 2,419,952 1,847,084 572,868
Leasehold improvements 64,028 15,789 48,239
---------------- ---------------- ----------------
$ 5,997,908 $ 3,083,492 $ 2,914,416
================ ================ ================
- 16 -
Note 6. Bank Building, Equipment, Furniture and Fixtures (Continued)
Depreciation expense amounted to $ 260,581, $ 285,683, and $ 271,803 for
2002, 2001, and 2000, respectively.
Note 7. Income Taxes
The components of federal income tax expense are summarized as follows:
2002 2001 2000
Current year provision $ 450,884 $ 299,269 $ 281,186
Deferred income taxes resulting from:
Differences between financial
statement and tax depreciation charges 48,049 ( 4,793) ( 14,708)
Differences between financial
statement and tax loan loss
provision ( 15,129) ( 24,758) ( 18,868)
Differences between financial statement
and tax retirement benefit expense ( 10,388) ( 14,207) ( 18,461)
--------- --------- ---------
Applicable income tax $ 473,416 $ 255,511 $ 229,149
========= ========= =========
Federal income taxes were computed after adjusting pretax accounting income
for nontaxable income in the amount of $ 537,475, $ 578,139, and $ 570,394
for 2002, 2001, and 2000, respectively.
A reconciliation of the effective applicable income tax rate to the federal
statutory rate is as follows:
2002 2001 2000
Federal income tax rate 34.0% 34.0% 34.0%
Reduction resulting from:
Nontaxable income 5.9 13.7 14.6
----- ----- -----
Effective income tax rate 28.1% 20.3% 19.4%
===== ===== =====
Deferred income taxes at December 31 are as follows:
2002 2001
Deferred tax assets $ 321,989 $ 296,472
Deferred tax liabilities ( 270,286) ( 135,943)
--------- ---------
$ 51,703 $ 160,529
========= =========
The tax effects of each type of significant item that gives rise to deferred
taxes are:
2002 2001
Net unrealized (gains) losses on
securities available for sale ($ 200,301) ($ 114,007)
Depreciation expense ( 69,985) ( 21,936)
Retirement benefit reserve 71,082 60,694
Allowance for loan losses 250,907 235,778
---------- ---------
$ 51,703 $ 160,529
========== =========
The Corporation has not recorded a valuation allowance for the deferred tax
assets as management feels that it is more likely than not that they will be
ultimately realized.
- 17 -
Note 8. Employee Benefit Plans
The Corporation has a 401-K plan which covers all employees who have attained
the age of 20 and who have completed six months of full-time service. The
plan provides for the Corporation to match employee contributions to a
maximum of 5% of annual compensation. The Corporation also has the option to
make additional discretionary contributions to the plan based upon the
Corporation's performance and subject to approval by the Board of Directors.
The Corporation's total expense for this plan was $ 84,699, $ 94,923, and
$ 105,078, for the years ended December 31, 2002, 2001, and 2000,
respectively.
The Corporation adopted three supplemental retirement benefit plans for
directors and executive officers. These plans are funded with single premium
life insurance on the plan participants. The cash value of the life
insurance policies is an unrestricted asset of the Corporation. The estimated
present value of future benefits to be paid totaled $ 209,066 and $ 178,512
at December 31, 2002 and 2001, respectively, which is included in other
liabilities. Total annual expense for these plans amounted to $ 81,516,
$ 55,656, and $ 54,406, for 2002, 2001, and 2000, respectively.
Note 9. Deposits
Included in savings deposits are NOW and Super NOW account balances totaling
$ 7,449,001 and $ 7,647,991 at December 31, 2002 and 2001, respectively.
Also included in savings deposits at December 31, 2002 and 2001 are Money
Market account balances totaling $ 7,789,010 and $ 11,179,592, respectively.
Time certificates of $ 100,000 and over as of December 31 were as follows:
2002 2001
(000 omitted)
Three months or less $ 960 $ 1,304
Three months to six months 1,385 855
Six months to twelve months 1,954 1,533
Over twelve months 9,096 9,004
--------- --------
Total $ 13,395 $ 12,696
========= ========
Interest expense on time deposits of $ 100,000 and over aggregated $ 658,000,
$ 726,000, and $ 699,000 for 2002, 2001, and 2000, respectively.
At December 31, 2002 the scheduled maturities of certificates of deposit are
as follows (000 omitted):
2003 $ 19,877
2004 15,209
2005 14,242
2006 6,678
2007 9,929
--------------
$ 65,935
==============
- 18 -
Note 9. Deposits (Continued)
The Corporation accepts deposits of the officers, directors and employees of
the corporation and its subsidiary on the same terms, including interest
rates, as those prevailing at the time for comparable transactions with
unrelated persons. The aggregate dollar amount of deposits of officers,
directors and employees totaled$ 2,223,487 and $ 2,367,738 at December 31,
2002 and 2001, respectively.
The aggregate amount of demand deposit overdrafts reclassified as loan
balances were $ 14,046 and $ 24,846 at December 31, 2002 and 2001,
respectively.
Derivative Instruments
Included in time deposits are Index Powered Certificates of Deposit
("IPCD's") totaling $ 1,296,562 and $ 1,055,108 at December 31, 2002 and
2001, respectively. The IPCD product is offered through a program with the
Federal Home Loan Bank (FHLB). The ultimate pay off at maturity, which is in
five years, is the initial deposited principal plus the appreciation in the
S&P 500 Index ("S&P Call Option"). The S&P Call Option is considered an
embedded derivative designated as a non-hedging item. The change in fair
value of the S&P Call Option resulted in gains of $ 219,023 and $ 16,347 for
2002 and 2001, respectively, which are included in other income.
In order to hedge its risk associated with the IPCD Product, the Corporation
has entered into a derivative contract with the FHLB whereby the Corporation
pays FHLB a fixed rate interest charge (ranging from 4.2% to 4.97%) in return
for a guarantee that the FHLB will pay the Corporation the cash equivalent of
the growth in the S&P 500 Index due at the IPCD maturity date. The change in
fair value of the FHLB Derivative Contract resulted in losses of $ 176,702
and $ 7,615 for 2002 and 2001, respectively, which is included in other
income.
Note 10. Financial Instruments With Off-Balance-Sheet Risk
The Corporation is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financial needs of its
customers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
balance sheets. The contract amounts of those instruments reflect the extent
of involvement the Corporation has in particular classes of financial
instruments.
The Corporation's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit
and standby letters of credit is represented by the contractual amount of
those instruments. The Corporation uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
Contract or
Notional Amount
(000 omitted)
2002 2001
Financial instruments whose contract amounts
represent credit risk at December 31:
Commitments to extend credit $ 12,513 $ 12,494
Commercial and standby letters of credit 2,230 1,644
-------- --------
$ 14,743 $ 14,138
======== ========
- 19 -
Note 10. Financial Instruments With Off-Balance-Sheet Risk (Continued)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Corporation
evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Corporation upon
extension of credit, is based on management's credit evaluation of the
customer. Collateral held varies but may include accounts receivable,
inventory, real estate, equipment, and income-producing commercial
properties.
Standby letters of credit are conditional commitments issued by the
corporation to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loans to customers. The
Corporation holds collateral supporting those commitments when deemed
necessary by management.
Note 11. Concentration of Credit Risk
The Corporation grants agribusiness, commercial and residential loans to
customers located in South Central Pennsylvania and Northwestern Maryland.
Although the Corporation has a diversified loan portfolio, a portion of its
customers' ability to honor their contracts is dependent upon the
construction and land development and agribusiness economic sectors as
disclosed in Note 3.
The Corporation evaluates each customer's creditworthiness on a case-by-case
basis. The amount of collateral obtained, if deemed necessary upon the
extension of credit, is based on management's credit evaluation of the
customer. Collateral held varies but generally includes equipment and real
estate.
The Corporation maintains deposit balances at correspondent banks, which
provide check collection and item processing services to the Corporation.
The balances with these correspondent banks, at times, exceed federally
insured limits, which management considers to be a normal business risk.
Note 12. FNB Financial Corporation (Parent Company Only) Financial
Information
The following are the condensed balance sheets, statements of income and
statements of cash flows for the parent company.
Balance Sheets
December 31, 2003
Assets 2002 2001
Cash $ 9,105 $ 22,665
Interest-bearing deposits with banks 165,897 6,395
Marketable equity securities
available for sale 96,846 185,002
Investment in the First National Bank
of McConnellsburg 14,162,837 13,368,499
Other assets 38,892 21,436
---------------- ---------------
Total assets $ 14,473,577 $ 13,603,997
================ ===============
- 20 -
Note 12. FNB Financial Corporation (Parent Company Only) Financial
Information (Continued)
Liabilities and Stockholders' Equity
Assets 2002 2001
Dividends payable $ 264,000 $ 216,000
Other liabilities 32,754 0
--------------- ---------------
296,754 216,000
Common stock, par value $ .315; 12,000,000
shares authorized; 800,000 shares issued
and outstanding 252,000 252,000
Additional paid-in capital 1,789,833 1,789,833
Retained earnings 11,746,170 11,124,857
Accumulated other comprehensive income 388,820 221,307
--------------- ---------------
Total stockholders' equity 14,176,823 13,387,997
--------------- ---------------
Total liabilities and stockholders' equity $ 14,473,577 $ 13,603,997
============== ==============
Statements of Income
Years Ended December 31
2002 2001 2000
Cash dividends from wholly-owned
Subsidiary $ 569,000 $ 542,000 $ 436,000
Interest on deposits with banks 388 303 330
Dividend income - Marketable
equity securities 4,641 5,369 5,938
Securities gains 42,691 7,843 0
Miscellaneous income (loss) 11,397 ( 4,168) 0
Equity in undistributed income of
Subsidiary 621,158 503,389 540,277
1,249,275 1,054,736 982,545
Less: holding company expenses 35,962 49,605 27,964
-------------- -------------- ---------------
Net income $ 1,213,313 $ 1,005,131 $ 954,581
============== ============== ===============
- 21 -
Note 12. FNB Financial Corporation (Parent Company Only) Financial
Information (Continued)
Statements of Cash Flows
Years Ended December 31
2002 2001 2000
Cash flows from operating activities:
Net income $ 1,213,313 $ 1,005,131 $ 954,581
Adjustments to reconcile net
income to cash provided by
operating activities:
Equity in undistributed income
of subsidiary ( 621,158) ( 503,389) ( 540,277)
(Gain) on sales of investments ( 42,691) ( 7,843) 0
(Increase) decrease in other assets ( 14,537) ( 17,857) ( 1,080)
Increase (decrease) in other liabilities 32,754 ( 6,065) ( 10,238)
Net cash provided by operating activities 567,681 469,977 402,986
-------------- -------------- ---------------
Cash flows from investing activities:
Net (increase) decrease in interest bearing
deposits with banks ( 159,502) ( 6,096) 6,618
Purchase of marketable equity securities
available for sale ( 143,866) 0 0
Sales of marketable equity securities
available for sale 266,127 38,720 0
-------------- -------------- ---------------
Net cash provided (used) by investing
Activities ( 37,241) 32,624 6,618
-------------- -------------- ---------------
Cash flows from financing activities:
Cash dividends paid ( 544,000) ( 480,000) ( 436,000)
-------------- -------------- ---------------
Net increase (decrease) in cash ( 13,560) 22,601 ( 26,396)
Cash, beginning balance 22,665 64 26,460
-------------- -------------- ---------------
Cash, ending balance $ 9,105 $ 22,665 $ 64
============== ============== ==============
Note 13. Regulatory Matters
Dividends paid by FNB Financial Corporation are generally provided from the
dividends it receives from its Subsidiary Bank. The Bank, as a National
Bank, is subject to the dividend restrictions set forth by the Office of the
Comptroller of the Currency (OCC). Under such restrictions, the Corporation
may not, without prior approval of the OCC, declare dividends in excess of
the sum of the current year's earnings (as defined) plus the retained
earnings (as defined) from the prior two years. The dividends that the Bank
could declare without the approval of the OCC amounted to approximately
$ 3,690,009 and $ 3,056,386 at December 31, 2002 and 2001, respectively.
- 22 -
Note 13. Regulatory Matters (Continued)
FNB Financial Corporation's balance of retained earnings at December 31, 2002
is $ 11,746,170 and would be available for cash dividends, although payment
of dividends to such extent would not be prudent or likely. The Federal
Reserve Board, which regulates bank holding companies, establishes guidelines
which indicate that cash dividends should be covered by current period
earnings.
The Corporation is also 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 Corporation's financial statements. Under capital
adequacy guidelines, the Corporation is required to maintain minimum capital
ratios. The "leverage ratio" compares capital to adjusted total balance
sheet assets. "Tier I" and "Tier II" capital ratios compare capital to risk-
weighted assets and off-balance sheet activity. A comparison of the
Corporation's capital ratios to regulatory minimums at December 31 is as
follows:
FNB Financial Corporation Regulatory Minimum
2002 2001 Requirements
Leverage ratio 10.50% 9.88% 4%
Risk-based capital ratios:
Tier I (core capital) 15.63% 14.89% 4%
Combined Tier I and
Tier II (core capital
plus allowance for loan
losses) 16.69% 15.90% 8%
As of December 31, 2002 the most recent regulatory exam from the Office of
the Comptroller of the Currency categorized the Corporation as well
capitalized under the regulatory frame work for prompt corrective action.
There are no conditions or events since that notification that management
believes have changed the Corporation's category.
Note 14. Compensating Balance Arrangements
Required deposit balances at the Federal Reserve were $ 100,000 and
$ 650,000 for 2002 and 2001, respectively. Required deposit balance at
Atlantic Central Banker's Bank was $ 425,000 at December 31, 2002 and 2001.
These balances are maintained to cover processing costs and service charges.
- 23 -
Note 15. Fair Value of Financial Instruments
The estimated fair values of the Corporation's financial instruments were as
follows at December 31:
- - - - - - - 2002 - - - - - - - - - - - - - - 2001 - - - - - - -
Carrying Fair Carrying Fair
Amount Value Amount Value
FINANCIAL ASSETS
Cash and due from banks $ 3,650,351 $ 3,650,351 $ 5,400,929 $ 5,400,929
Federal funds sold 0 0 6,000,000 6,000,000
Interest-bearing deposits
in banks 968,266 990,976 2,572,574 2,589,534
Securities available for sale 20,583,684 20,583,684 19,554,290 19,554,290
Securities to be held to
Maturity 692,839 692,188 1,114,764 1,088,460
Other bank stock 666,000 666,000 833,700 833,700
Loans receivable 100,526,867 100,695,330 90,167,678 92,256,899
Accrued interest receivable 658,856 658,856 619,464 619,464
FINANCIAL LIABILITIES
Time certificates 65,934,931 68,165,120 65,647,473 67,998,882
Other deposits 44,757,428 44,757,428 46,314,907 46,314,907
Accrued interest payable 403,813 403,813 586,433 586,433
Liability for borrowed funds 7,232,659 8,004,310 5,403,458 5,763,175
Note 16. Liability for Borrowed Funds
Included in liabilities for borrowed funds at December 31 are borrowings from
The Federal Home Loan Bank as follows:
Type Advance Principal Outstanding
Amount 2002 2001 Interest Rate Maturity Date
Convertible (1) $ 2,250,000 $ 2,250,000 $ 2,250,000 6.23% 8/30/10
Convertible (1) 2,000,000 2,000,000 2,000,000 5.83% 8/10/10
Convertible (1) 500,000 500,000 500,000 5.98% 7/21/10
Convertible (1) 500,000 500,000 500,000 6.54% 7/12/10
Credit Line 17,750,000 1,835,000 0 1.31% 12/31/03
CIP/Term (2) 175,000 147,659 153,458 6.64% 7/14/17
----------- -----------
$ 7,232,659 $ 5,403,458
=========== ===========
(1) Interest rates on Convertible Loans are fixed until the market rate
reaches a pre-determined Comparative Rate/Index or Strike Rate/Index, at
which time the interest rate becomes adjustable quarterly based upon the
three month LIBOR rate. At the time any loan rate becomes adjustable, the
Corporation has the option to repay the debt entirely without penalty or
convert to a repayment schedule.
- 24 -
Note 16. Liability for Borrowed Funds (Continue)
(2) The Corporation received Community Investment Program funding from the
Federal Home Loan Bank of Pittsburgh for $ 175,000 at a fixed rate of 6.64%
and an amortization term of 20 years. Required payments on this loan are as
follows:
2003 $ 6,214
2004 6,639
2005 7,094
2006 7,737
2007 8,098
Thereafter 111,877
------------------
$ 147,659
==================
The total maximum borrowing capacity from Federal Home Loan Bank at
December 31, 2002 was $ 54,470,000. Collateral for borrowings at the
Federal Home Loan Bank consists of various securities and the Corporation's
1-4 family mortgages with a total value of approximately $ 60,414,000.
Note 17. Operating Lease
The Corporation leases its Hancock, Maryland office. The original lease
term is ten years with three separate successive options to extend the
lease for a term of five years each. Monthly rent is $ 1,800 and the lessee
pays a proportionate share of other operating expenses. For the years ended
December 31, 2002, 2001, and 2000, rent expense under this operating lease
was $ 21,600 for each year. Required lease payments for the remaining four
years are as follows:
2003 $ 21,600
2004 21,600
2005 21,600
2006 16,200
----------
$ 81,000
==========
Note 18. Commitments
In the fourth quarter of 2002, the Corporation entered into contracts with
certain vendors for the replacement of its data processing and information
technology system. Total cost of the project is estimated at $ 495,000.
Open commitments on contractual obligations approximated $ 328,000 at
December 31, 2002. Implementation of the new system is expected to be
completed in the first quarter of 2003.
- 25 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
SELECTED FIVE YEAR FINANCIAL DATA
2002 2001 2000 1999 1998
Results of Operations (000 omitted)
Interest income $ 8,352 $ 8,767 $ 8,755 $ 7,802 $ 7,721
Interest expense 3,723 4,676 4,697 4,119 4,112
Provision for loan losses 142 144 231 190 475
------- ------- ------- ------- -------
Net interest income after
provision for loan losses 4,487 3,947 3,827 3,493 3,134
Other operating income 693 739 624 621 530
Other operating expenses 3,494 3,425 3,267 3,030 2,772
------- ------- ------- ------- -------
Income before income taxes 1,686 1,261 1,184 1,084 892
Applicable income tax 473 256 229 181 110
------- ------- ------- ------- -------
Net income $ 1,213 $ 1,005 $ 955 $ 903 $ 782
======= ======= ======= ======= =======
Common Share Data
Per share amounts are based on weighted average shares of common stock
outstanding of 800,000 for 2002, 2001, 2000, 1999, and 1998 after giving
retroactive recognition to a two-for-one stock split issued September 1,
2000.
Income before income taxes $ 2.11 $ 1.58 $ 1.48 $ 1.36 $ 1.12
Applicable income taxes 0.59 0.32 0.29 0.22 0.14
Net income 1.52 1.26 1.19 1.13 0.98
Cash dividend declared 0.74 0.63 0.57 0.50 0.41
Book value (actual number
of shares outstanding) 17.72 16.73 15.69 14.00 14.90
Dividend payout ratio 48.79% 50.14% 47.76% 44.28% 41.43%
Year-End Balance Sheet Figures
(000 omitted)
Total assets $ 133,365 $ 132,161 $ 123,626 $ 117,929 $ 113,565
Net loans 100,527 90,168 83,112 76,137 61,901
Total investment securities -
Amortized cost 20,687 20,334 28,154 31,900 35,348
Deposits-noninterest bearing 13,931 13,344 11,798 10,959 10,819
Deposits-interest bearing 96,761 98,618 91,834 88,371 89,685
Total deposits 110,692 111,962 103,632 99,330 100,504
Total stockholders' equity 14,177 13,388 12,548 11,201 11,917
Ratios
Average equity/average assets 10.30% 10.05% 10.15% 10.49% 10.53%
Return on average equity 9.01% 7.74% 7.67% 7.53% 6.85%
Return on average assets 0.93% 0.78% 0.78% 0.79% 0.72%
- 26 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
SUMMARY OF QUARTERLY FINANCIAL DATA
The unaudited quarterly results of operations for the years ended
December 31, 2002 and 2001 are as follows:
2002 2001
($ 000 omitted Quarter Ended Quarter Ended
except per share) Mar.31 June 30 Sept. 30 Dec. 31 Mar.31 June 30 Sept. 30 Dec. 31
Interest income $ 2,036 $ 2,073 $ 2,082 $ 2,161 $ 2,245 $ 2,222 $ 2,188 $ 2,112
Interest expense 982 931 931 879 1,236 1,217 1,160 1,063
------- ------- ------- ------- ------- ------- ------- -------
Net interest income 1,054 1,142 1,151 1,282 1,009 1,005 1,028 1,049
Provision for loan losses 30 36 37 39 36 36 36 36
------- ------- ------- ------- ------- ------- ------- -------
Net interest income
after provision for
loan losses 1,024 1,106 1,114 1,243 973 969 992 1,013
Other income 181 162 163 142 143 170 169 239
Security gains (losses) 8 0 19 18 6 4 4 4
Other expenses 853 832 890 919 844 863 833 885
------- ------- ------- ------- ------- ------- ------- -------
Operating income
before
income taxes 360 436 406 484 278 280 332 371
Applicable income taxes 80 72 156 165 41 50 64 101
------- ------- ------- ------- ------- ------- ------- -------
Net income $ 280 $ 364 $ 250 $ 319 $ 237 $ 230 $ 268 $ 270
======= ======= ======= ======= ======= ======= ======= =======
Net income applicable
to common stock
Per share data:
Net income $ 0.35 $ 0.46 $ 0.31 $ 0.40 $ 0.30 $ 0.30 $ 0.33 $ 0.26
- 27 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS
EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL
Years Ended December 31
Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- - - - - - - 2002 - - - - - - - - - - - - 2001 - - - - - - - - - - - - 2000 - - - - - -
(000 omitted) (000 omitted) (000 omitted)
ASSETS
Interest bearing
deposits with banks
and federal funds sold $ 5,870 $ 123 2.18% $ 8,614 $ 305 3.54% $ 1,200 $ 72 6.00%
Investment securities 19,048 936 .91% 24,037 1,322 5.50% 30,571 1,780 5.82%
Loans 96,209 7,293 7.58% 86,059 7,141 8.30% 80,900 6,903 8.53%
--------- -------- ----- --------- -------- ----- ---------- -------- -----
Total interest
earning assets 121,127 $ 8,352 6.89% 118,710 $ 8,768 7.39% $ 112,671 $ 8,755 7.77%
======== ===== ======== ===== ======== =====
Cash and due from
Banks 3,743 3,342 3,746
Bank premises and
Equipment 2,827 3,017 3,072
Other assets 2,854 4,158 3,200
--------- --------- ---------
Total assets $ 130,551 $ 129,227 $ 122,689
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest bearing
transaction accounts $ 6,876 $ 49 0.70% $ 8,118 $ 94 1.16% $ 8,148 $ 109 1.34%
Money market deposit
Accounts 8,303 150 1.81% 11,830 366 3.09% 8,460 332 3.92%
Other savings deposits 15,299 190 1.24% 10,995 215 1.96% 11,095 256 2.31%
All time deposits 65,920 2,999 4.54% 65,214 3,669 5.63% 61,863 3,544 5.73%
Liability for borrowed
Funds 5,433 335 6.17% 5,410 333 6.16% 7,468 456 6.11%
--------- -------- ----- --------- -------- ----- ---------- -------- -----
Total interest
bearing
liabilities 101,831 3,723 2.67% 101,567 4,677 4.60% 97,034 4,697 4.84%
======== ===== ======== ===== ======== =====
Demand deposits 14,172 13,399 12,047
Other liabilities 1,097 1,274 1,149
--------- --------- ---------
Total liabilities 117,100 116,240 110,230
Stockholders' equity 13,451 12,987 12,459
--------- --------- ---------
Total liabilities
and stockholders'
equity $ 130,551 $ 129,227 $ 122,689
========= ========= =========
Net interest income/net
interest margin $ 4,629 3.82% $ 4,091 3.45% $ 4,058 3.59%
======== ===== ======== ===== ======== =====
Note: Average loan balances presented include loans placed on non-accrual
status.
- 28 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
CHANGES IN NET INTEREST INCOME
- - - - 2002 Compared to 2001 - - - - - - - - 2001 Compared to 2000 - - -
Total Total
Average Average Increase Average Average Increase
(000 omitted) Volume Rate (Decrease) Volume Rate (Decrease)
Interest Income
Interest bearing deposits
with banks and
federal funds sold ($ 97) ($ 85) ($ 182) $ 445 ($ 212) $ 233
Investment securities ( 274) ( 112) ( 386) ( 380) ( 78) ( 458)
Loans 842 ( 690) 152 440 ( 202) 238
------ ------ ------- ------- ------- --------
Total interest income $ 471 ($ 887) ($ 416) $ 505 ($ 492) $ 13
====== ====== ======= ======= ======= ========
Interest Expense
Interest bearing
transaction accounts ($ 14) ($ 31) ($ 45) $ 0 ($ 15) ($ 15)
Money market
deposit accounts ( 109) ( 107) ( 216) 132 ( 98) 34
Other savings 84 ( 109) ( 25) ( 2) ( 39) ( 41)
All time deposits 40 ( 710) ( 670) 192 ( 67) 125
Liability for borrowed funds 2 0 2 ( 126) 3 ( 123)
------ ------ ------- ------- ------- --------
Total interest expense $ 3 ($ 957) ($ 954) $ 196 ($ 216) ($ 20)
====== ====== ======= ======= ======= ========
Net interest income $ 538 $ 33
======= ========
- 29 -
FNB FINANCIAL CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARY
MATURITIES OF INVESTMENT SECURITIES
December 31, 2002
The following table shows the maturities of investment securities at
amortized cost as of December 31, 2002, and weighted average yields of such
securities. Yields are shown on a taxable equivalent basis, assuming a 34%
federal income tax rate.
(000 omitted)
Within 1 Year 1-5 Years 5-10 Years Over 10 Years Total
Obligations of other U.S.
Government agencies:
Amortized cost $ 3,750 $ 1,649 $ 199 $ 265 $ 5,863
Yield 5.93% 5.88% 6.55% 7.50% 6.01%
Obligations of state and
political subdivisions:
Amortized cost 645 5,729 1,472 469 8,315
Yield 4.32% 3.82% 4.09% 4.82% 3.97%
Mortgage-Backed securities
and SBA Guaranteed Loan
Pool Certificates (1):
Amortized cost 4 64 926 5,415 6,409
Yield 9.58% 5.41% 5.48% 4.40% 4.57%
------------- --------- --------- ------------- --------
Subtotal amortized
Cost 4,399 7,442 2,597 6,149 20,587
------------- --------- --------- ------------- --------
Subtotal yield 5.70% 4.29% 4.77% 4.57% 4.74%
------------- --------- --------- ------------- --------
Equity Securities $ 100
Yield 1.70%
---------
Total investment securities $ 20,687
========
Yield 4.72%
========
(1) It is anticipated that these mortgage-backed securities and SBA
Guaranteed Loan Pool Certificates will be repaid prior to their
contractual maturity dates.
- 30 -
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following section presents a discussion and analysis of the
financial condition and results of operations of FNB Financial Corporation
(the Corporation) and its wholly-owned subsidiary, The First National Bank of
McConnellsburg (the Bank). This discussion should be read in conjunction with
the financial tables/statistics, financial statements and notes to
financial statements appearing elsewhere in this annual report.
RESULTS OF OPERATIONS
Overview
Consolidated net income for 2002 was $ 1,213,313, a $ 208,182, or
20.7% increase from the net income for 2001 of $ 1,005,131, and an increase
in 2001 net income of $ 50,550, or 5.3% from the net income of $ 954,581 for
2000. On a per share basis, net income for 2002 was $ 1.52, based upon
average shares outstanding of 800,000, compared to $ 1.26 for 2001 and $ 1.19
for 2000.
Net Interest Income
Total interest income decreased $ 416,000 from 2001 to 2002 and
increased $ 13,000 from 2000 to 2001. Decreases in 2002 were due to
reduction in rates while increases in 2001 were primarily due to volume
increase in average earning assets. Average loans outstanding in 2002
increased 11.8% over 2001 as the bank continues to penetrate the Washington
County, Maryland market. Average rates continued to decline throughout 2002
which caused a $ 690,000 decrease in earnings from loans compared to 2001.
However, the aforementioned increase in volume of loans during 2002
compensated for the drop in rates and caused overall interest earnings from
loans to increase $ 152,000 or 2.1% over 2001. Earnings on investments
(excluding gains from sales) decreased 29.2% in 2002 compared to a 25.7%
decrease in 2001. This decrease was a combination of a decrease in volume
with available funds being directed into loans as investments rolled off and
a decrease in average yields. Total average earning assets increased 2.0% in
2002 compared to 5.4% in 2001. Increases in earning assets during 2002 and
2001 were proportionately higher in loans, which typically produce higher
yields than investments thus producing the higher earnings during 2002 and
2001.
Interest from loans accounted for 87.3% of total interest income
for 2002, as compared to 81.4% and 78.8% for 2001 and 2000, respectively.
Total interest expense was $ 3,723,000 for 2002, a decrease of
$ 954,000 over the $ 4,677,000 for 2001. The increase in total average
deposits was .9% in 2002 compared to 7.8% in 2001. Overall growth was flat
during 2002 with interest bearing demand deposits decreasing 23.9% and time
deposits and savings increasing 1.1% and 39.1%, respectively. Although
overall growth was flat during 2002, rates decreased 193 basis points which
caused a decrease in interest expense on deposits of 22%. There were no
significant changes in the level of borrowed funds resulting in interest
expense on borrowed funds remaining consistent with 2001. The changes in
volume of earning assets along with the decreased level of rates paid for
deposits caused the overall net interest margin to increase from 3.45% in
2001 to 3.82% in 2002.
Allowance for Loan Losses and Related Provisions
The loan loss provision is an estimated expense charged to
earnings in anticipation of losses attributable to uncollectible loans.
The provision is based on our analysis of the adequacy of the allowance for
loan losses. The provision for 2002 was $ 142,000, compared to $ 144,000 for
2001, and $ 231,319 for 2000.
- 31 -
The changes in the allowance for loan losses are presented in Note
4 of the financial statements. Net change-offs in 2002 were $ 96,000
compared to $ 73,000 in 2001 and $ 166,000 in 2000, representing .1%, .08%
and .2% of average loans outstanding for 2002, 2001 and 2000, respectively.
Impaired loans in 2002, 2001, and 2000 represent one credit
relationship, details of which are presented in Note 4 to the financial
statements. This loan is performing and is well collateralized.
Management utilizes a comprehensive systematic review of our loan
portfolio on a quarterly basis in order to determine the adequacy of the
Allowance for Loan Losses. Each quarter the loan portfolio is categorized
into various Pools as follows:
POOL #1 Specific allowances for any individually identified
trouble loans
POOL #2 Commercial and Industrial
POOL #3 Commercial and Industrial - Real Estate Secured
POOL #4 Consumer Demand and Installment
POOL #5 Guaranteed Loans and Farmers and Commercial
POOL #6 Consumer Mortgage and Home Equity
POOL #7 Real Estate Secured - Farmland
Lines of credit and non-secured commercial loans with balances of
$ 100,000 and over are individually reviewed. Also, loans that are 90 days
or more past due or have been previously classified as substandard are
individually reviewed. Allocations to the Allowance for Loan Losses are
based upon classifications assigned to those loans.
Loan classifications utilized are consistent with OCC regulatory
guidelines and are as follows:
Allowance Factors
-----------------
Loss Charge-off
Doubtful 20% - 50%
Substandard 10% - 20%
Special Mention 5% - 10%
Watch 1% - 5%
The remaining portion of the Pools are evaluated as groups with
allocations made to the allowance based on historical loss experience,
current and anticipated trends in delinquencies, and general economic
conditions within the bank's trading area.
In addition to the aforementioned internal loan review, the Bank
engages an outside firm to annually conduct an independent loan review in
order to validate the methodologies used internally and to independently test
the adequacy of the Allowance for Loan Losses.
Delinquencies are well below peer group averages and management is
not aware of any problem loans other than those disclosed herein that are
indicative of trends, events, or uncertainties that would significantly
impact operations, liquidity or capital.
Other Operating Income and Other Operating Expenses
Other income represents service charges on deposit accounts,
commissions and fees received for the sale of travelers' checks, money orders
and savings bonds, fees for trust referrals, fees for investment services,
securities gains, and losses, increases in cash surrender value of life
insurance, and other income, such as safe deposit box rents. Other income
decreased $ 45,000 or 6.1% for 2002 over 2001, and increased $ 115,000 or
18.4% for 2001 over 2000. The changes relate primarily to service charges
and other fees related to deposits which fluctuated with the related changes
in volumes of deposits discussed earlier.
- 32 -
The noninterest expenses are classified into five main categories:
salaries; employee benefits; occupancy expenses, which include depreciation,
maintenance, utilities, taxes and insurance; equipment expenses, which
include depreciation, rents and maintenance; and other operating expenses,
which include all other expenses incurred in operating the Corporation.
Overall personnel related expenses increased slightly in 2002 over
2001. Salaries and wages decreased as the result of changes in personnel
during 2002. However, the cost of benefits increased resulting in an overall
increase of .6% for 2002. Increases from 2000 to 2001 were primarily the
result of compensation rate increases.
Occupancy, furniture and equipment expenses were relatively
consistent from 2000 through 2002. However, management has evaluated and
revised its technology plan and will be converting the core processing
applications to a new system in 2003, which management expects will increase
equipment costs in 2003.
Other expenses increased 8.3% in 2002 compared to 2001 and 3.9% in
2001 compared to 2000. Increases were primarily in processing costs,
professional development, professional fees and directors benefits.
Income Taxes
Applicable income taxes changed between 2000, 2001 and 2002 as a
result of changes in pre-tax accounting income and taxable income. Details
of income tax expense are presented in Note 7 to the financial statements.
As described in Note 1 of the Notes to Consolidated Financial Statements,
deferred income taxes have been provided for timing differences in the
recognition of certain expenses between financial reporting and tax purposes.
Deferred income taxes have been provided at prevailing tax rates for such
items as depreciation, provision for loan losses, deferred compensation, and
unrealized gains and losses on investment securities available for sale as
accounted for under SFAS 115. The marginal tax rate at which deferred taxes
were provided during 2002 and 2001 is 34%. At December 31, 2002 and 2001,
deferred taxes amounted to $ 51,703 and $ 160,529, respectively. If all
timing differences reversed in 2003, the actual income taxes saved by the
recognition of the aforementioned expenses would not be significantly
different from the deferred income taxes recognized for financial reporting
purposes.
The current level of nontaxable investment and loan income is such
that the Corporation is not affected by the alternative minimum tax rules.
CRITICAL ACCOUNTING POLICIES
Bank policy related to the allowance for loan losses is considered
to be a critical accounting policy because the allowance for loan losses
represents a particularly sensitive accounting estimate. The amount of the
allowance is based on management's evaluation of the collectibility of the
loan portfolio, including the nature of the loan portfolio, credit
concentrations, trends in historical loss experience, specific impaired
loans, and economic conditions.
The allowance for loan losses is established through a provision
for loan losses charged to expense. Loans are charged against the allowance
for loan losses when management believes the collectibility of the principal
is unlikely. The allowance is an amount management believes will be adequate
to absorb possible losses on existing loans that may become uncollectible,
based on evaluations of the collectibility of loans and prior loan loss
experience. The evaluations take into consideration such factors as changes
in the nature and volume of the loan portfolio, overall portfolio quality,
review of specific problem loans, and current economic conditions that may
affect the borrowers' ability to pay.
- 33 -
FUTURE IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Financial Accounting Standards Board (FASB) Standard 142, which
was effective for years beginning after December 15, 2001, addressed the
financial accounting and reporting for acquired goodwill and other intangible
assets. It does not address intangibles acquired as part of business
combinations which is addressed by FASB 141. This statement also addresses
how goodwill and intangibles are accounted for after they have been initially
recognized. Management has evaluated the impact of this statement on the
consolidated financial statements and has determined it is not material.
Financial Accounting Standards Board (FASB) Standard 148,
Accounting for Stock-Based Compensation-Transition and Disclosure, an
amendment of FASB 123. This statement amends FASB Statement No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based
method of accounting for stock-based employee compensation. It also amends
the disclosure provisions of Statement 123 to require prominent disclosure
about the effects on reported net income of an entity's accounting policy
decisions with respect to stock-based employee compensation. Finally, this
Statement amends APB Opinion No. 28, Interim Financial Reporting, to require
disclosure about those effects in interim financial information. The
Corporation does not have any stock option plan, therefore, SFAS No. 148 will
have no affect.
LIQUIDITY AND RATE SENSITIVITY
Our optimal objective is to maintain adequate liquidity while
minimizing interest rate risk. Adequate liquidity provides resources for
credit needs of borrowers, for depositor withdrawals, and for funding
corporate operations. Sources of liquidity are maturing/called investment
securities; maturing overnight investments in federal funds sold; maturing
investments in time deposits at other banks; readily accessible interest-
bearing deposits at other banks; payments on loans, mortgage-backed
securities and SBA Guaranteed Loan Pool Certificates; a growing core deposit
base; and borrowings from the FHLB.
In order to assure a constant and stable source of funds, we are a
member of the Federal Home Loan Bank of Pittsburgh. This membership assures
us the availability of both short term and long term fixed rate funds. As of
December 31, 2002, we had borrowings of $ 7,232,659 from this institution and
had readily available to us over $ 54,470,000 in additional borrowing
capacity. As of December 31, 2001, we had borrowings of $ 5,403,458 from
this institution and had readily available to us over $ 39,400,000 in
additional borrowing capacity.
The objective of managing interest rate sensitivity is to maintain
or increase net interest income by structuring interest-sensitive assets and
liabilities in such a way that they can be repriced in response to changes in
market interest rates. Based upon contractual maturities of securities and
the capability of NOW, Money Market, and Savings accounts, we have maintained
a negative rate sensitivity position, in that, rate sensitive liabilities
exceed rate sensitive assets. Therefore, in a period of declining interest
rates our net interest income is generally enhanced versus a period of rising
interest rates where our net interest margin may be decreased. In a period of
declining interest rates, more securities with call features will most likely
be called and will be reinvested into lower yielding investments resulting in
the loss of higher interest earnings assets. However, during 2002, the
run-off of investments was redirected into loans which produce higher yields
than investments even in a declining interest rate environment. This shift
in earning assets as evidenced by the change in the loan to deposit ratios of
79.6%, 78.5% and 87.0% for 2000, 2001 and 2002, respectively, aided in
improving the net interest margins.
Presently, interest rates are anticipated to remain depressed
further resulting in a decreasing cost of deposits while a portion of our
adjustable rate loans and securities continue repricing to lower interest
rates. This decreasing interest rate environment and the possibility of
lower interest rates in the future have
- 34 -
LIQUIDITY AND RATE SENSITIVITY (Continued)
resulted in increased liquidity in investment debt securities as call
features of U. S. Government Agencies and State and Municipal subdivisions
in the U. S. are anticipated to be exercised by the issuer. The anticipated
result of this current position will be a decrease in the yield on earning
assets. We have also undertaken the position of decreasing the cost of our
interest-bearing liabilities, specifically Time Certificates of Deposit.
Following these actions, we expect our net interest spread and interest
margin to decrease slightly during the next few months. We continually
review interest rates on those deposits which can be changed immediately,
specifically NOW accounts, Money Market Accounts, and Savings Accounts to
determine if interest rate changes are necessary to maintain our net interest
spread and net interest margin.
Our interest rate sensitivity analysis as of December 31, 2002,
based upon our historical prepayment mortgage-backed securities, contractual
maturities, and the earliest possible repricing opportunity for loans and
deposits is as follows:
December 31, 2002 (000 omitted)
After 3 After 1
But But
Within 3 Within 12 Within 5 After 5
Months Months Years Years Total
Rate Sensitive Assets:
Investment securities
(book value) $ 680 $ 3,819 $ 7,442 $ 8,746 $ 20,687
Interest-bearing balances
due from banks 292 481 195 0 968
Loans 8,682 6,223 12,783 72,832 100,520
------- -------- -------- -------- ---------
$ 9,654 $ 10,523 $ 20,420 $ 81,578 $ 122,175
======= ======== ======== ======== =========
Rate Sensitive Liabilities:
NOW accounts and savings accounts $ 30,521 $ 0 $ 0 $ 0 $ 30,521
Time deposits 6,222 13,655 46,058 0 65,935
Other time deposits 0 306 0 0 306
Other borrowed money 0 1,841 30 5,362 7,233
------- -------- -------- -------- ---------
$ 36,743 $ 15,802 $ 46,088 $ 5,362 $ 103,995
======= ======== ======== ======== =========
Interest sensitivity gap ($ 27,089) ($ 5,279) ($ 25,668) $ 76,216 $ 18,180
Cumulative interest sensitivity gap ( 27,089) ( 32,368) ( 58,036) 18,180
RSA/RSL - cumulative ( 0.26) ( 0.38) ( 0.41) 1.17
We have risk management policies to monitor and limit exposure
to market risk. By monitoring reports which assess our exposure to market
risk, we strive to enhance our net interest margin and take advantage of
opportunities available in interest rate movements.
- 35 -
MARKET RISK MANAGEMENT
The continual monitoring of liquidity and interest rate risk is
a function of ALCO reporting. Upon review and analysis of these reports, we
determine the appropriate methods we should utilize to reprice our products,
both loans and deposits, and the types of securities we should purchase in
order to achieve desired net interest margin and interest spreads. We
continually strive to attract lower cost deposits, and we competitively price
our time deposits and loan products in order to maintain favorable interest
spreads while minimizing interest rate risk.
The following table sets forth the projected maturities and average
rate for all rate sensitive assets and liabilities. The following assumptions
were used in the development of this table:
* All fixed and variable rate loans were based on the original maturity of
the note.
* All fixed and variable rate U. S. Agency and Treasury securities and
obligations of state and political subdivisions in the U.S. were based
upon the contractual maturity date.
* All fixed and variable rate Mortgage-backed securities and SBA GLPCs
were based upon original maturity as the Bank has not experienced a significant
prepayment of these securities.
* We have experienced very little run-off in our history of operations and
have experienced net gains in deposits.
* We have large business and municipal deposits in non-interest bearing
checking and savings and interest-bearing checking. These balances may
fluctuate significantly. Therefore, a 50% maximum runoff of both non-
interest-bearing checking and savings and interest-bearing checking was
used as an assumption in this table.
* Fixed and variable rate time deposits were based upon original contract
maturity dates.
- 36 -
Rate Sensitive Assets
(000 omitted) 2003 2004 2005 2006 2007 Thereafter Total Fair Value
Interest bearing deposits $ 773 $ 100 $ 0 $ 95 $ 0 $ 0 $ 968 $ 991
Average interest rate 5.22% 5.01% 0.00% 2.59% 0.00% 0.00% 4.81%
Fixed interest rate loans 1,700 4,348 1,700 2,457 1,503 28,744 40,452 40,896
Average interest rate 7.51% 7.46% 7.25% 7.45% 7.22% 7.65% 7.51%
Variable interest
rate loans 13,205 469 501 332 1,473 44,088 60,068 60,727
Average interest rate 6.52% 6.21% 6.31% 6.19% 5.75% 6.19% 6.27%
Fixed interest rate
U.S. Agency
and Treasury 3,750 572 968 109 0 464 5,863 6,034
Average interest rate 5.93% 5.59% 5.81% 8.20% 0.00% 6.40% 6.01%
Fixed interest rate
mortgage-backed & 4 0 64 0 0 742 810 817
SBA GLPC securities
Average interest rate 9.58% 0.00% 5.41% 0.00% 0.00% 6.76% 6.67%
Variable interest rate
mortgaged-backed 0 0 0 0 0 5,599 5,599 5,644
& SBA GLPC securities
Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 4.25% 4.25%
Fixed interest rate
obligations of state
and political
subdivisions in the U.S. 645 1,606 1,181 1,671 1,271 1,941 8,315 8,684
Average interest rate 4.32% 3.20% 3.57% 4.10% 4.31% 4.26% 3.97%
Rate Sensitive Liabilities
(000 omitted)
Noninterest-bearing
checking 3,481 871 871 871 871 0 6,965 6,965
Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Savings and interest-
bearing checking 7,632 1,907 1,907 1,907 1,907 0 15,260 15,260
Average interest rate 0.82% 0.82% 0.82% 0.82% 0.82% 0.00% 0.82%
Fixed interest rate
time deposits 16,098 13,023 9,708 4,568 7,078 0 50,475 52,182
Average interest rate 3.56% 4.02% 4.25% 4.31% 4.21% 0.00% 4.12%
Variable interest
rate time deposits 3,779 2,186 4,534 2,110 2,851 0 15,460 15,983
Average interest rate 4.15% 4.12% 3.97% 3.75% 4.12% 0.00% 3.99%
Fixed interest rate
Borrowing 0 0 0 0 0 148 148 168
Average interest rate 0.00% 0.00% 0.00% 0.00% 0.00% 6.64% 6.64%
Variable interest
rate borrowings 1,835 0 0 0 0 5,250 7,085 7,836
Average interest rate 1.31% 0.00% 0.00% 0.00% 0.00% 6.08% 4.84%
- 37 -
CAPITAL
The primary method by which we increase total stockholders' equity
is through the accumulation of earnings. We maintain ratios that are well
above the minimum total capital levels required by federal regulatory
authorities including the risk-based capital guidelines. Regulatory
authorities have established capital guidelines in the form of the "leverage
ratio" and "risk-based capital ratios." Our leverage ratio is defined as total
stockholders' equity less intangible assets to total assets. The risk-based
ratios compare capital to risk-weighted assets and off-balance-sheet activity
in order to make capital levels more sensitive to risk profiles of individual
banks. A comparison of our capital ratios to regulatory minimums at
December 31 is as follows:
Regulatory
Minimum
2002 2001 2000 Requirements
Leverage ratio 10.50% 9.88% 10.03% 4.00%
Risk-based capital ratio
Tier I (core capital) 15.63% 14.89% 16.09% 4.00%
Combined Tier I and Tier II
(core capital plus allowance
for loan losses 16.69% 15.90% 17.15% 8.00%
We have traditionally been well-capitalized with ratios well above
required levels and, we expect equity capital to continue to exceed regulatory
guidelines and industry averages.
Certain ratios are useful in measuring the ability of a company to
generate capital internally. The following chart indicates the growth in
equity capital for the past three years.
2002 2001 2000
Equity capital at December 31 (000 omitted) $ 14,177 $ 13,388 $ 12,548
Equity capital as a percent of assets at December 31 10.63% 10.13% 10.15%
Return on average assets .93% 0.78% 0.78%
Return on average equity 9.01% 7.74% 7.67%
Cash dividend payout ratio 48.79% 50.14% 47.76%
STOCK MARKET ANALYSIS AND DIVIDENDS
Our common stock is traded inactively in the over-the-counter market.
As of December 31, 2002, the approximate number of shareholders of record was
460.
2002 2001
Market Price Cash Dividend Market Price Cash Dividend
HI LOW HI LOW
First Quarter $ 23.50 - 20.00 $ 0.12 $ 24.75 - 24.75 $ 0.11
Second Quarter 22.00 - 20.00 0.14 25.00 - 24.50 0.12
Third Quarter 22.50 - 22.00 0.15 25.00 - 23.00 0.13
Fourth Quarter 22.50 - 22.50 0.33 25.00 - 23.00 0.27
- 38 -
Exhibit 21
SUBSIDIARIES OF THE REGISTRANT
1. The First National Bank of McConnellsburg; a nationally chartered bank
2. established in 1906.
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OR THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of FNB Financial Corporation (the
"Company") on Form 10-K for the period ending December 31, 2002 as filed
with the Securities and Exchange Commission on the date therein specified
(the "Report:), I, John C. Duffey, President and Chief Executive Officer of
the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant
to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company as of and for the period covered by the Report.
By: /s/John C Duffey
John C. Duffey
President and Chief
Executive Officer,
Director
Dated: March 25, 2003
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OR THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of FNB Financial Corporation(the
"Company") on Form 10-K for the period ending December 31, 2002 as filed
with the Securities and Exchange Commission on the date therein specified
(the "Report"), I, Dale M. Fleck, Vice President, Controller, and Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C.
section 1350, as adopted pursuant to section 906 of the Sarbanes-
Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
(3) material respects, the financial condition and results of
(4) operations of the Company as of and for the period covered by
(5) the Report.
By: /s/Dale M. Fleck
Dale M. Fleck
Vice President Controller,
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
Dated: March 25, 2003