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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission File Number 0-15572
FIRST BANCORP
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(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
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(State of Incorporation) (I.R.S. Employer Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (910) 576-6171
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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:
COMMON STOCK, NO PAR VALUE
(Title of each class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] YES [ ] NO
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy of information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to the Form 10-K. [ ]
The aggregate market value of the voting stock, Common Stock, no par
value, held by non-affiliates of the registrant, based on the average bid and
asked prices of the Common Stock on February 29, 2000 as reported on the NASDAQ
National Market System, was approximately $47,959,296. Shares of Common Stock
held by each officer and director and by each person who owns 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
The number of shares of the Registrant's Common Stock outstanding on
February 29, 2000 was 4,534,666.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed pursuant to
Regulation 14A are incorporated herein by reference into
Part III.
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CROSS REFERENCE INDEX
Begins on
Page (s)
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PART I Business:
Item I General Description 4
Statistical Information
Net Interest Income 13, 32
Average Balances and Net Interest Income Analysis 13, 32
Volume and Rate Variance Analysis 13, 33
Provision for Loan Losses 15, 38
Noninterest Income 15, 33
Noninterest Expenses 16, 33
Income Taxes 17, 34
Distribution of Assets and Liabilities 17, 34
Securities Portfolio Composition and Maturities 18, 34
Loans 19, 36
Nonperforming Assets 20, 37
Allowance for Loan Losses and Loan Loss Experience 21, 37
Deposits 22, 38
Borrowings 24
Interest Rate Risk (Including Quantitative
and Qualitative Disclosures About Market Risk) 24, 39
Off-Balance Sheet Risk 26
Return on Assets and Equity 27, 40
Liquidity 27
Capital Resources, Components and Ratios 27, 41
Y2K Issue 29
Inflation 29
Current accounting matters 29
Forward-Looking Statements 29
Item 2 Properties 10
Item 3 Legal Proceedings 10
Item 4 Submission of Matters to a Vote of Shareholders 11
PART II
Item 5 Market for the Registrant's Common Stock and Related
Shareholder Matters 11
Item 6 Selected Financial Data 11, 31
Item 7 Management's Discussion and Analysis of Results of
Operations and Financial Condition 11
Item 7A Quantitative and Qualitative Disclosures About Market Risk 24
Item 8 Financial Statements and Supplementary Data:
Consolidated Balance Sheets as of December 31, 1999 and 1998 43
Consolidated Statements of Income for each of the years in the
three-year period ended December 31, 1999 44
Consolidated Statements of Comprehensive Income for each of the
years in the three-year period ended December 31, 1999 45
Consolidated Statements of Shareholders' Equity for each of the years
in the three-year period ended December 31, 1999 46
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended December 31, 1999 47
Notes to Consolidated Financial Statements 48
Independent Auditors' Report 68
Selected Consolidated Financial Data 31
Quarterly Financial Summary 42
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 69
2
PART III
Item 10 Directors and Executive Officers of the Registrant; Compliance
with Section 16 (a) of the Exchange Act 69*
Item 11 Executive Compensation 69*
Item 12 Security Ownership of Certain Beneficial Owners and Management 69*
Item 13 Certain Relationships and Related Transactions 69*
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports of Form 8-K 69
SIGNATURES 73
* Information called for by Part III (Items 10 through 13) is incorporated
herein by reference to the Registrant's definitive Proxy Statement for the
2000 Annual Meeting of Shareholders to be filed with Securities and
Exchange Commission.
3
PART I
Item 1. Business
General Description
The Company
First Bancorp (the "Company") is a one-bank holding company. The principal
activity of the Company is the ownership and operation of First Bank (the
"Bank"), a state chartered bank with its main office in Troy, North Carolina.
The Company also owns and operates two nonbank subsidiaries, Montgomery Data
Services, Inc. ("Montgomery Data"), a data processing company, and First Bancorp
Financial Services, Inc. ("First Bancorp Financial"), which currently owns and
operates various real estate. The Bank has two wholly-owned subsidiaries, First
Bank Insurance Services, Inc. and First Troy Realty Corporation. First Bank
Insurance Services, Inc. ("First Bank Insurance"), formerly an insurance agency,
was acquired in 1994 in connection with the Company's acquisition of Central
State Bank - see below. On December 29, 1995, the insurance agency operations of
First Bank Insurance were divested. From December 1995 until October 1999, First
Bank Insurance was an inactive subsidiary of the Bank. In October 1999, First
Bank Insurance began operations again as a provider of non-FDIC insured
investments and insurance products. First Troy Realty Corporation ("First Troy")
was incorporated on May 12, 1999 as a subsidiary of the Bank. First Troy allows
the Bank to centrally manage a portion of its residential, mortgage, and
commercial real estate loan portfolio.
The Company was incorporated in North Carolina on December 8, 1983, as
Montgomery Bancorp, for the purpose of acquiring 100% of the outstanding common
stock of the Bank through stock-for-stock exchanges. On December 31, 1986, the
Company changed its name to First Bancorp to conform its name to the name of the
Bank, which had changed its name from Bank of Montgomery to First Bank in 1985.
The Bank was organized in 1934 and began banking operations in 1935 as the
Bank of Montgomery, named for the county in which it operated. With its 1995
acquisition of the Laurinburg and Rockingham offices of First Scotland Bank and
its 1994 acquisition of Central State Bank , High Point, North Carolina, the
Bank operates in a 14 county area centered in Troy, North Carolina. Troy,
population 3,400, is located in the center of Montgomery County, approximately
60 miles east of Charlotte, 50 miles south of Greensboro, and 80 miles southwest
of Raleigh. The Bank conducts business from 34 branches located within an
80-mile radius of Troy, covering a geographical area from Maxton to the
southeast, to High Point to the north, Kannapolis to the west, and Lillington to
the east. Ranked by assets, the Bank was the 16th largest bank in North Carolina
as of December 31, 1999, according to the North Carolina Office of the
Commissioner of Banks.
The Bank has three de novo branches scheduled to open in 2000. The Bank
plans to open branches in March or April of 2000 in Pittsboro, Chatham County,
North Carolina and Salisbury, Rowan County, North Carolina. The Bank plans to
open a branch in Apex, Wake County, North Carolina in the fall of 2000.
The Bank provides a full range of banking services, including the accepting
of demand and time deposits, the making of secured and unsecured loans to
individuals and businesses, and the offering of credit cards and debit cards. In
1999, as in recent prior years, the Bank accounted for substantially all of the
Company's consolidated net income.
The Company's principal executive offices are located at 341 North Main
Street, Troy, North Carolina 27371-0508, and its telephone number is (910)
576-6171. Unless the context otherwise requires, references to the "Company" in
this annual report on Form 10-K shall mean collectively First Bancorp and its
subsidiaries.
4
General Business
The Bank engages in a full range of banking activities, providing such
services as checking, savings, NOW and money market accounts and other time
deposits of various types; loans for business, agriculture, real estate,
personal uses, home improvement and automobiles; credit cards; debit cards;
letters of credit; IRA's; safe deposit box rentals; bank money orders; and
electronic funds transfer services, including wire transfers, automated teller
machines, and bank-by-phone capabilities. Because the majority of the Bank's
customers are individuals and small to medium-sized businesses located in the
counties it serves, deposits and loans are well diversified. There are no
seasonal factors that tend to have any material effect on the Bank's business,
and the Bank does not rely on foreign sources of funds or income.
First Bank Insurance was an inactive subsidiary of the Bank from December
1995 until October 1999. Beginning in October 1999, First Bank Insurance began
offering non-FDIC insured investment and insurance products, including mutual
funds, annuities, long-term care insurance, life insurance, and company
retirement plans, as well as financial planning services. First Bank Insurance
collects commissions for the services it provides. Commissions earned during
October to December 1999 were less than $10,000. The line item entitled
"Commissions from sales of insurance" in Table 4 and in the Consolidated
Statements of Income is primarily comprised of commissions from the Bank's sale
of credit life insurance associated with loans it originates.
Montgomery Data's primary business is to provide electronic data
processing services for the Bank, which accounted for approximately 97% of its
data processing revenue in 1999 compared to 99% of its data processing revenues
in 1998 and 82% in 1997. Ownership and operation of Montgomery Data allows the
Company to do all of its electronic data processing without paying fees for such
services to an independent provider. Maintaining its own data processing system
also allows the Company to adapt the system to its individual needs and to the
services and products it offers. Although not a significant source of income,
Montgomery Data has historically made its excess data processing capabilities
available to area financial institutions for a fee. The Company had one
nonaffiliated customer in 1996 and for the first eleven months of 1997, at which
time the customer terminated its contract as a result of being acquired by
another institution and paid an early termination fee. The Company did not have
any nonaffiliated customers from December 1997 to December 1998. In December
1998, a contract was signed to provide data processing for a nearby start-up
bank. This customer contributed approximately $40,000 in fees during 1999. In
March 1999, Montgomery Data was contracted to perform limited item processing
services for another de novo bank in the area at an annual rate that is
currently approximately $12,000.
First Bancorp Financial was organized under the name of First Recovery in
September of 1988 for the purpose of providing a back-up data processing site
for Montgomery Data and other financial and non-financial clients. First
Recovery's back-up data processing operations were divested in 1994. First
Bancorp Financial now owns and leases the First Recovery building. First Bancorp
Financial periodically purchases parcels of real estate from the Bank that were
acquired through foreclosure. The parcels purchased consist of real estate
having various purposes. First Bancorp Financial actively pursues the sale of
these properties.
First Troy was incorporated on May 12, 1999 as a subsidiary of the Bank.
First Troy allows the Bank to centrally manage a portion of its residential,
mortgage, and commercial real estate loan portfolio. First Troy has elected to
be treated as a real estate investment trust for tax purposes.
Territory Served and Competition
The Company serves primarily the south central area of the Piedmont region
of North Carolina, with offices in Anson, Cabarrus, Chatham, Davidson, Guilford,
Harnett, Lee, Montgomery, Moore, Randolph, Richmond, Robeson, Scotland and
Stanly counties. The Company's headquarters are located in Troy, Montgomery
County. The Company's 34 branches and facilities are all located in small
communities whose economies are based primarily on manufacturing and light
industry. Although the Company's market is predominantly small communities and
rural areas, the area is not dependent on agriculture. Textiles, furniture,
mobile homes, electronics, plastic and metal fabrication, forest products, food
products and cigarettes are among the leading
5
manufacturing industries in the trade area. Leading producers of socks, hosiery
and area rugs are located in Montgomery County. The Pinehurst area is a widely
known golf resort and retirement area. The High Point area is widely known for
its furniture market. Additionally, several of the communities served by the
Company are "bedroom" communities serving Charlotte and Greensboro in addition
to smaller cities such as Albermarle, Asheboro, High Point, Pinehurst and
Sanford.
The banking laws of North Carolina allow state-wide branching, and
consequently commercial banking in the state is highly competitive. The Company
competes in its various market areas with, among others, several large
interstate bank holding companies that are headquartered in North Carolina.
These large competitors have substantially greater resources than the Company,
including broader geographic markets, higher lending limits and the ability to
make greater use of large-scale advertising and promotions. A significant number
of interstate banking acquisitions have taken place in the past decade, thus
further increasing the size and financial resources of some of the Company's
competitors, four of which are among the largest bank holding companies in the
nation. See "Supervision and Regulation" below for a further discussion of
regulations in the Company's industry that affect competition.
The Company competes not only against banking organizations, but also
against a wide range of financial service providers, including federally and
state chartered savings and loan institutions, credit unions, investment and
brokerage firms and small-loan or consumer finance companies. Competition among
financial institutions of all types is virtually unlimited with respect to legal
ability and authority to provide most financial services. However, the Company
believes it has certain advantages over its competition in the areas it serves.
The Company seeks to maintain a distinct local identity in each of the
communities it serves and actively sponsors and participates in local civic
affairs. Most lending and other customer-related business decisions can be made
without delays often associated with larger systems. Additionally, employment of
local managers and personnel in various offices and low turnover of personnel
enable the Company to establish and maintain long-term relationships with
individual and corporate customers.
Lending Policy and Procedures
Conservative lending policies and procedures and appropriate underwriting
standards are high priorities of the Bank. Loans are approved under the Bank's
written loan policy, which provides that lending officers, principally branch
managers, have sole authority to approve loans of various amounts up to $75,000.
Each of the Bank's regional senior lending officers has sole discretion to
approve secured loans in principal amounts up to $250,000 and together can
approve loans up to $1,000,000. Lending limits may vary depending upon whether
the loan is secured or unsecured.
The Bank's board of directors reviews and approves loans that exceed
management's lending authority, loans to officers, directors, and their
affiliates and, in certain instances, other types of loans. New credit
extensions are reviewed daily by the Bank's senior management and at least
monthly by the board of directors.
The Bank continually monitors its loan portfolio to identify areas of
concern and to enable management to take corrective action. Lending officers and
the board of directors meet periodically to review past due loans and portfolio
quality, while assuring that the Bank is appropriately meeting the credit needs
of the communities it serves. Individual lending officers are responsible for
pursuing collection of past-due amounts and monitoring any changes in the
financial status of the borrowers.
The Bank's internal audit department evaluates specific loans and overall
loan quality at individual branches as part of its regular branch reviews. The
internal audit department also maintains its own estimate of the required amount
of allowance for loan losses needed for the overall Company which is compared to
the loan department's estimate for consistency. See "Allowance for Loan Losses
and Loan Loss Experience" in Item 7 below.
The Bank also contracts with an independent consulting firm to review new
loan originations meeting certain criteria, as well as assign risk grades to
existing credits meeting certain thresholds. The consulting firm's
6
observations, comments and risk grades are shared with the Company's audit
committee of the board of directors, and are considered by management in setting
Bank policy, as well as in evaluating the adequacy of the allowance for loan
losses.
Investment Policy and Procedures
The Company has adopted an investment policy designed to optimize the
Company's income from funds not needed to meet loan demand in a manner
consistent with appropriate liquidity and risk objectives. Pursuant to this
policy, the Company may invest in federal, state and municipal obligations,
federal agency obligations, public housing authority bonds, industrial
development revenue bonds, Federal National Mortgage Association ("FNMA"),
Government National Mortgage Association ("GNMA") and Student Loan Marketing
Association ("SLMA") securities. The policy also contains maximum amounts that
the Company can invest in certain types of securities, including, at December
31, 1999, a maximum of $30 million that can be invested in certain
collateralized mortgage obligations and mortgage-backed securities. The
Company's investments must be rated at least BAA by Moody's or BBB by Standard
and Poor's. Securities rated below A are periodically reviewed for
creditworthiness. The Company may purchase non-rated municipal bonds only if
such bonds are in the Company's general market area and determined by the
Company to have a credit risk no greater than the minimum ratings referred to
above. Industrial development authority bonds, which normally are not rated, are
purchased only if they are judged to possess a high degree of credit soundness
to assure reasonably prompt sale at a fair value.
The Company's investment officers implement the investment policy, monitor
the investment portfolio, recommend portfolio strategies, and report to the
Company's investment committee. Reports of all purchases, sales, net profits or
losses and market appreciation or depreciation of the bond portfolio are
reviewed by the Company's board of directors each month. Once a quarter, the
Company's interest rate risk exposure is monitored by the board of directors.
Once a year, the written investment policy is reviewed by the board of directors
and the Company's portfolio is compared with the portfolios of other companies
of comparable size.
All of the Company's securities are kept in safekeeping accounts at
correspondent banks.
Recent Acquisitions
As part of its operations, the Company regularly evaluates the potential
acquisition of or merger with, and holds discussions with, various financial
institutions.
On December 16, 1999, in a joint press release, First Bancorp and First
Savings Bancorp, Inc. (First Savings) announced the signing of a definitive
merger agreement, the basic terms of which call for the Company to issue 1.2468
shares of its stock in exchange for each share of First Savings stock. First
Savings is a savings institution headquartered in Southern Pines, North Carolina
with six offices and $330 million in total assets as of December 31, 1999. As of
the same date, First Savings had $224 million in loans and $232 million in
deposits. The merger is expected to be consummated in the second quarter of
2000.
On November 14, 1997, the Bank acquired a First Union National Bank branch
located in Lillington, North Carolina. Real and personal property acquired
totaled approximately $237,000 and deposits assumed totaled approximately
$14,345,000. No loans were included in the purchase.
On December 15, 1995, the Bank completed a cash acquisition of the
Laurinburg and Rockingham branch offices of First Scotland Bank. As of December
15, 1995, assets acquired were approximately $15.8 million. The acquisition
included earning assets of approximately $14.2 million, of which approximately
$8.9 million were loans. Deposit liabilities assumed were approximately $15
million.
On August 25, 1994, the Company completed a cash acquisition of Central
State Bank in High Point, North Carolina. Central State, a North Carolina
state-chartered commercial bank, had approximately $35 million in assets at the
time of the acquisition, with earning assets of approximately $32 million,
including approximately $27
7
million in loans. Central State also had approximately $32 million in deposits
at the time of the merger.
Employees
As of December 31, 1999, the Company had 254 full-time and 49 part-time
employees. The Company is not a party to any collective bargaining agreements
and considers its employee relations to be good.
Supervision and Regulation
As a bank holding company, the Company is subject to supervision,
examination and regulation by the Board of Governors of the Federal Reserve
System and the North Carolina Office of the Commissioner of Banks. The Bank is
subject to supervision and examination by the Federal Deposit Insurance
Corporation and the North Carolina Office of the Commissioner of Banks. See also
note 14 to the consolidated financial statements.
Supervision and Regulation of the Company
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
required to register as such with the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board" or "FRB"). The Company also is regulated by
the North Carolina Office of the Commissioner of Banks (the "Commissioner")
under the Bank Holding Company Act of 1984.
A bank holding company is required to file with the Federal Reserve Board
quarterly reports and other information regarding its business operations and
those of its subsidiaries. It is also subject to examination by the Federal
Reserve Board and is required to obtain Federal Reserve Board approval prior to
making certain acquisitions of other institutions or voting securities. The
Commissioner is empowered to regulate certain acquisitions of North Carolina
banks and bank holding companies, issue cease and desist orders for violations
of North Carolina banking laws, and promulgate rules necessary to effectuate the
purposes of the Bank Holding Company Act of 1984.
Regulatory authorities have cease and desist powers over bank holding
companies and their nonbank subsidiaries where their actions would constitute a
serious threat to the safety, soundness or stability of a subsidiary bank. Those
authorities may compel holding companies to invest additional capital into
banking subsidiaries upon acquisition or in the event of significant loan losses
or rapid growth of loans or deposits.
On November 12, 1999, President Clinton signed into law legislation that
allows bank holding companies to engage in a wider range of non-banking
activities, including greater authority to engage in securities and insurance
activities. Under the Gramm-Leach-Bliley Act (the "Act"), a bank holding company
that elects to become a financial holding company may engage in any activity
that the Federal Reserve Board, in consultation with the Secretary of the
Treasury, determines by regulation or order is (i) financial in nature, (ii)
incidental to any such financial activity, or (iii) complementary to any such
financial activity and does not pose a substantial risk to the safety or
soundness of depository institutions or the financial system generally. This Act
makes significant changes in U.S. banking law, principally by repealing certain
restrictive provisions of the 1933 Glass-Steagall Act. The Act specifies certain
activities that are deemed to be financial in nature, including lending,
exchanging, transferring, investing for others, or safeguarding money or
securities; underwriting and selling insurance; providing financial, investment,
or economic advisory services; underwriting, dealing in or making a market in,
securities; and any activity currently permitted for bank holding companies by
the Federal Reserve Board under Section 4(c)(8) of the Holding Company Act. The
Act does not authorize banks or their affiliates to engage in commercial
activities that are not financial in nature. A bank holding company may elect to
be treated as a financial holding company only if all depository institution
subsidiaries of the holding company are well-capitalized, well-managed and have
at least a satisfactory rating under the Community Reinvestment Act.
National and state banks are also authorized by the Act to engage, through
"financial subsidiaries," in any
8
activity that is permissible for a financial holding company (as described
above) and any activity that the Secretary of the Treasury, in consultation with
the Federal Reserve Board, determines is financial in nature or incidental to
any such financial activity, except (i) insurance underwriting, (ii) real estate
development or real estate investment activities (unless otherwise permitted by
law), (iii) insurance company portfolio investments and (iv) merchant banking.
The authority of a national or state bank to invest in a financial subsidiary is
subject to a number of conditions, including, among other things, requirements
that the bank must be well-managed and well-capitalized (after deducting from
the bank's capital outstanding investments in financial subsidiaries).
The Act also contains a number of other provisions that will affect the
Company's operations and the operations of all financial institutions. One of
the new provisions relates to the financial privacy of consumers, authorizing
federal banking regulators to adopt rules that will limit the ability of banks
and other financial entities to disclose non-public information about consumers
to non-affiliated entities. These limitations will likely require more
disclosure to consumers, and in some circumstances, will require consent by the
consumer before information is allowed to be provided to a third party.
At the present time, the Company does not anticipate applying for status as
a financial holding company under the Act. At this time, no predictions can be
made regarding the impact the Act may have upon the Company's financial
condition or results of operations.
The United States Congress and the North Carolina General Assembly have
periodically considered and adopted legislation that has resulted in, and could
result in further, deregulation of both banks and other financial institutions.
Such legislation could modify or eliminate geographic restrictions on banks and
bank holding companies and current restrictions on the ability of banks to
engage in certain nonbanking activities. For example, the Riegle-Neal Interstate
Banking Act, which was enacted several years ago, allows expansion of interstate
acquisitions by bank holding companies and banks. This and other legislative and
regulatory changes have increased the ability of financial institutions to
expand the scope of their operations, both in terms of services offered and
geographic coverage. Such legislative changes could place the Company in more
direct competition with other financial institutions, including mutual funds,
securities brokerage firms, insurance companies, and investment banking firms.
The effect of any such legislation on the business of the Company cannot be
predicted. The Company cannot predict what other legislation might be enacted or
what other regulations might be adopted or, if enacted or adopted, the effect
thereof on the Company's business.
Supervision and Regulation of the Bank
Federal banking regulations applicable to all depository financial
institutions, among other things, (i) provide federal bank regulatory agencies
with powers to prevent unsafe and unsound banking practices; (ii) restrict
preferential loans by banks to "insiders" of banks; (iii) require banks to keep
information on loans to major shareholders and executive officers; and (iv) bar
certain director and officer interlocks between financial institutions.
As a state chartered bank, the Bank is subject to the provisions of the
North Carolina banking statutes and to regulation by the Commissioner. The
Commissioner has a wide range of regulatory authority over the activities and
operations of the Bank, and the Commissioner's staff conducts periodic
examinations of banks and their affiliates to ensure compliance with state
banking regulations. Among other things, the Commissioner regulates the merger
and consolidations of state-chartered banks, the payment of dividends, loans to
officers and directors, recordkeeping, types and amounts of loans and
investments, and the establishment of branches. The Commissioner also has cease
and desist powers over state-chartered banks for violations of state banking
laws or regulations and for unsafe or unsound conduct that is likely to
jeopardize the interest of depositors.
The dividends that may be paid by the Bank to the Company are subject to
legal limitations under the North Carolina law. In addition, the regulatory
authorities may restrict dividends that may be paid by the Bank or the Company's
other subsidiaries. The ability of the Company to pay dividends to its
shareholders is largely dependent on the dividends paid to the Company by its
subsidiaries.
9
The Bank is a member of the Federal Deposit Insurance Corporation (the
"FDIC"), which currently insures the deposits of member banks. For this
protection, each bank pays a quarterly statutory assessment, based on its level
of deposits, and is subject to the rules and regulations of the FDIC. The FDIC
also is authorized to approve conversions, mergers, consolidations and
assumptions of deposit liability transactions between insured banks and
uninsured banks or institutions, and to prevent capital or surplus diminution in
such transactions where the resulting, continuing, or assumed bank is an insured
nonmember bank. In addition, the FDIC monitors the Bank's compliance with
several banking statutes, such as the Depository Institution Management
Interlocks Act and the Community Reinvestment Act of 1977. The FDIC also
conducts periodic examinations of the Bank to assess its compliance with banking
laws and regulations, and it has the power to implement changes in or
restrictions on a bank's operations if it finds that a violation is occurring or
is threatened.
Neither the Company nor the Bank can predict what other legislation might
be enacted or what other regulations might be adopted, or if enacted or adopted,
the effect thereof on the Bank's operations.
See "Capital Resources" under Item 7 - Management's Discussion and Analysis
below for a discussion of regulatory capital requirements.
Item 2. Properties
The main offices of the Company, the Bank and First Bancorp Financial
are located in a three-story building in the central business district of Troy,
North Carolina. The building houses administrative, training and bank teller
facilities. The Bank's Operations Division, including customer accounting
functions, offices and operations of Montgomery Data, and offices for loan
operations, are housed in a one-story steel frame building approximately
one-half mile west of the main office. The Company operates 34 branches and
facilities, including the main office, in the trade area as follows: Troy - main
office and one additional full service branch and one teller-window facility;
Albemarle, Asheboro, and Sanford - two full service branches in each; Pinehurst
- - one full service branch and one teller-window facility; Aberdeen, Angier,
Archdale, Biscoe, Bennett, Candor, Denton, High Point, Kannapolis, Laurel Hill,
Laurinburg, Lillington, Locust, Maxton, Pinebluff, Polkton, Richfield, Robbins,
Rockingham, Seagrove, Seven Lakes, Southern Pines, and Vass - one full service
branch in each. The Company owns all its premises except eight branch offices
for which the land and buildings are leased and one branch office for which the
land is leased but the building is owned. There are no other options to purchase
or lease additional properties. The Company considers its facilities adequate to
meet current needs.
Item 3. Legal Proceedings
Various legal proceedings may arise in the ordinary course of business and
may be pending or threatened against the Company and/or its subsidiaries. The
Company is not involved in any pending legal proceedings that management
believes could have a material effect on the consolidated financial position of
the Company.
10
Item 4. Submission of Matters to a Vote of Shareholders
No matters were submitted to the shareholders during the fourth quarter of
1999.
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder
Matters
The Company's common stock trades on the NASDAQ National Market System of
The NASDAQ Stock Market under the symbol FBNC. Tables 1 and 21, included in
"Management's Discussion and Analysis" below, set forth the high and low market
prices of the Company's common stock as traded by the brokerage firms that
maintain a market in the Company's common stock and the dividends declared for
the periods indicated. All per share amounts have been restated from their
originally reported amount to reflect the three-for-two stock split distributed
in September 1999 and the two-for-one stock split that was distributed in
September 1996. See "Business - Supervision and Regulation" and note 14 to the
consolidated financial statements for a discussion of regulatory restrictions on
the payment of dividends. As of February 29, 2000, there were approximately
1,000 shareholders of record and an estimated 800 shareholders whose stock is
held in "street name."
Item 6. Selected Financial Data
Table 1 on page 31 sets forth selected financial data about the Company.
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Management's discussion and analysis is intended to assist readers in
understanding the Company's results of operations and changes in financial
position for the past three years. This review should be read in conjunction
with the consolidated financial statements and accompanying notes beginning on
page 43 of this report and the supplemental financial data contained in Tables 1
through 21 included with this discussion and analysis. All per share amounts
have been restated to reflect the three-for-two stock split distributed on
September 13, 1999 to shareholders of record on August 30, 1999 and the
two-for-one stock split distributed on September 13, 1996 to shareholders of
record on August 30, 1996.
Mergers and Acquisitions
On December 16, 1999, in a joint press release, First Bancorp and First
Savings Bancorp, Inc. (First Savings) announced the signing of a definitive
merger agreement, the basic terms of which call for the Company to issue 1.2468
shares of its stock in exchange for each share of First Savings stock. First
Savings is a savings institution headquartered in Southern Pines, North Carolina
with six offices and $330 million in total assets as of December 31, 1999. As of
the same date, First Savings had $224 million in loans and $232 million in
deposits. The merger is expected to be consummated in the second quarter of
2000.
On November 14, 1997, First Bank acquired a First Union National Bank
branch located in Lillington, North Carolina. Deposits assumed totaled
approximately $14,345,000. No loans were included in the purchase.
In the fourth quarter of 1995, First Bank completed a cash acquisition of
the Laurinburg and Rockingham branch offices of First Scotland Bank. Assets
acquired were approximately $15.8 million including earning assets of
approximately $14.2 million, of which approximately $8.9 million were loans.
Deposit liabilities assumed were approximately $15 million.
During the third quarter of 1994, the Company completed a cash acquisition
of Central State Bank in High Point, North Carolina. Central State had
approximately $35 million in assets with earning assets of approximately $32
million, including approximately $27 million in loans. Central State also had
approximately $32 million in deposits.
11
ANALYSIS OF RESULTS OF OPERATIONS
Net interest income, the "spread" between earnings on interest-earning
assets and the interest paid on interest-bearing liabilities, constitutes the
largest source of the Company's earnings. Other factors that significantly
affect operating results are the provision for loan losses, noninterest income
such as service fees and noninterest expenses such as salaries, occupancy
expense, equipment expense and other overhead costs, as well as the effects of
income taxes.
Overview - 1999 Compared to 1998
Net income for the year ended December 31, 1999 was a record $6,619,000, a
16.5% increase over the $5,683,000 reported for 1998. The 1999 net income
amounted to basic earnings per share of $1.46, a 16.8% increase over the $1.25
basic earnings per share in 1998. Diluted earnings per share for 1999 amounted
to $1.43, a 17.2% increase from the $1.22 reported for 1998.
The increase in earnings is primarily a result of the strong recent growth
the Company has experienced in its loan and deposit bases. In 1999, loans grew
by 17.0% and deposits grew by 9.0%. Additionally since January 1, 1998, the
Company's loans have grown by a total of 49.4% and deposits have increased by
32.9%. The effect of recognizing the net interest income on a full twelve months
of the 1998 loan and deposit growth, as well as the incremental impact of the
1999 growth resulted in an increase in net interest income of 11.9% in 1999
compared to 1998. Partially offsetting the effects of the loan and deposit
growth on net interest income was a decrease in the Company's net interest
margin from 5.24% in 1998 to 5.01% in 1999.
Because the Company's asset quality remained sound in 1999, and due to the
lower loan growth experienced in 1999 compared to 1998, the Company's provision
for loan losses of $910,000 in 1999 was slightly less than the $990,000
provision recorded in 1998.
The strong growth in the Company's loan and deposit bases has also driven
the Company's increase in noninterest income by providing access to more
customers to whom the Company can provide fee based services. In 1999, total
noninterest income increased 10.0% from $4,656,000 in 1998 to $5,121,000 in
1999. "Core" noninterest income, which excludes gains and losses from sales of
securities, loans, and other assets, as well as nonrecurrring items, increased
$677,000, or 15.4%, during 1999, from $4,405,000 in 1998 to $5,082,000 in 1999.
Noninterest income not defined as "core" amounted to $39,000 and $251,000 during
1999 and 1998, respectively, and is discussed in more detail below.
Noninterest expenses increased $1,904,000, or 12.0%, from $15,912,000 in
1998 to $17,816,000 in 1999. These higher operating expenses were experienced in
all areas of the Company's operations and are associated with the growth in the
Company's branch network and customer base.
The Company's income taxes increased 6.6% from $3,059,000 in 1998 to
$3,260,000 in 1999. The Company's effective tax rate decreased in 1999 to 33.0%
from 35.0% in 1998. The reduction in the effective tax rate is largely due to
the favorable state tax treatment of the real estate investment trust (First
Troy).
Overview - 1998 Compared to 1997
Net income for 1998 amounted to $5,683,000, a 13.4% increase over the
$5,012,000 earned in 1997. The 1998 net income amounted to $1.25 basic earnings
per share, a 12.6% increase over the $1.11 basic earnings per share in 1997.
Earnings per share on a diluted basis amounted to $1.22 in 1998 compared to
$1.08 in 1997, an increase of 13.0%. 1998 results included $227,000 (pretax) in
gains from commercial loan sales, which had not been common from a historical
perspective but were the type of gain that could occur again under certain
circumstances (and did occur, though to a lesser extent, in 1999). 1997 results
included $168,000 (pretax) in
12
nonrecurring income related to the receipt of an early termination fee for a
data processing contract.
A primary contributor to the growth in earnings during 1998 was a 16.1%
increase in the Company's net interest income. This increase was a result of
strong growth in loans and deposits. Partially offsetting the effects on
earnings of the loan and deposit growth was a decrease in the Company's net
interest margin and a higher provision for loan losses. The increase in the
provision for loan losses from $575,000 in 1997 to $990,000 in 1998 was
primarily attributable to the significant loan growth experienced by the
Company, and not because of concerns about the Company's asset quality.
Also contributing to the growth in earnings was a 12.2% increase in the
Company's noninterest income, which grew from $4,150,000 in 1997 to $4,656,000
in 1998, an increase of $506,000. Core noninterest income increased $387,000, or
9.6%, during 1998, from $4,018,000 in 1997 to $4,405,000 in 1998. Noninterest
income not defined as "core" amounted to $251,000 and $132,000 during 1998 and
1997, respectively, and is discussed in more detail below.
Noninterest expenses increased $1,824,000, or 12.9%, from $14,088,000 in
1997 to $15,912,000 in 1998. These higher operating expenses were experienced in
all areas of the Company's operations and were associated with the growth in the
Company's branch network and customer base.
Net Interest Income
Net interest income on a taxable-equivalent basis amounted to $24,058,000
in 1999, $21,649,000 in 1998, and $18,808,000 in 1997.
Table 2 analyzes net interest income on a taxable-equivalent basis. The
Company's net interest income on a taxable-equivalent basis increased by 11.1%
in 1999 and 15.1% in 1998. These increases in net interest income were primarily
a result of increases in the amount of average loans and deposits outstanding
when comparing 1999 to 1998 and 1998 to 1997. In 1999, the average amount of
loans outstanding grew by 18.7%, while the average amount of deposits increased
by 14.3%. In 1998, the average amount of loans outstanding increased 32.5% and
the average amount of deposits outstanding increased 23.8%.
The effects of the increases in average loans and deposits on
taxable-equivalent net interest income in both 1999 and 1998 were partially
offset by an overall narrowing of the Company's interest rate spread. The
Company's net interest margin (net yield on average interest-earning assets)
decreased 23 basis points to 5.01% in 1999 compared to 5.24% in 1998. 1998's
yield of 5.24% was 41 basis points lower than the 5.65% margin realized in 1997.
The Company's interest rate spread (the difference between the yield on
interest-earning assets and the rate paid on interest-bearing liabilities) also
declined with a decrease of 16 basis points in 1999 to 4.41% from 4.57% in 1998.
1998's interest rate spread of 4.57% was 39 basis points lower than the 4.96%
realized in 1997. Part of the reason for the Company's narrowing net interest
margin in 1999 was due to the Company's Y2K liquidity plan that was implemented
in the fourth quarter of 1999. The Company estimates that excluding the effects
of the excess liquidity called for by the plan that the net interest margin for
1999 would have been 5.06% and the interest rate spread would have been 4.46%.
Average interest rates over the past two years have been lower than the
immediately preceding year. The average prime rate in 1999 was 8.00% compared to
8.35% in 1998 and 8.44% in 1997. The lower interest rates have resulted in lower
yields earned on interest earning assets, as well as lower rates paid on
interest-bearing liabilities. However, over the past two years, the Company's
yields on its interest-earning assets have decreased by more than the average
rates paid on interest-bearing liabilities.
In 1999, the average loan yield decreased 44 basis points from 9.27% in
1998 to 8.83% in 1999. The 1998 yield of 9.27% was 40 basis points lower than
the 9.67% yield in 1997. The Company believes that there are two likely reasons
that the Company's loan yield has decreased at a greater rate than interest
rates in general. First, the Company's loan mix has experienced a continuing
slight shift from loans not secured by real estate to loans
13
secured by real estate. As Table 10 illustrates, loans secured by real estate
(construction and mortgage) as a percentage of the overall loan portfolio have
increased from 73.14% of the total portfolio at year end 1997 to 76.55% at year
end 1998 to 78.38% at year end 1999. The Company's loans secured by real estate
generally carry lower interest rates than loans not secured by real estate
because they typically are judged to have a lower risk of credit loss than loans
not secured by real estate. The disproportionate growth in loans secured by real
estate is associated with a strategic effort by the Company to more fully
leverage its balance sheet and branch network. The Company's average loans and
deposits per branch has historically been and continues to be low when compared
with industry averages. In the last two to three years, the Company has
implemented a high growth strategy to better leverage its branch network and
provide higher returns on shareholders' equity. This strategy has resulted in
the Company targeting higher balance loans, loans for which the Company
generally requires real estate as collateral. As noted above, loans secured by
real estate generally carry lower interest rates than loans not secured by real
estate. While lower interest rate loans have negatively impacted the Company's
net interest margin yields, they have incrementally added to the Company's
earnings. The second reason for decreasing loan yields has been that a
substantial amount of the Company's loan growth has occurred in markets that are
highly competitive. While the Company operates in some markets where competition
is more limited, a large percentage of the Company's loan growth in the past two
to three years has been in growing markets in the state where the Company faces
intense competition and must price its loans accordingly.
The yields the Company earns on its investment portfolio have also
declined. The yield earned on the Company's taxable investments, the large
majority of the Company's portfolio, declined from 6.72% in 1997 to 6.37% in
1998 to 5.75% in 1999. This decrease over the past two years has been due to the
lower trend in interest rates in the bond market and has been accelerated by
issuer calls of securities that had call options.
The average rates paid on interest-bearing liabilities have decreased less
than the decreases in yields on interest-earning assets. In 1999, the average
rate paid on interest bearing liabilities was 3.89%, or 26 basis points less
than the 4.15% average rate paid in 1998. The 1998 rate was 12 basis points
higher than the average rate paid of 4.03% in 1997. The primary reasons that
rates paid on interest bearing liabilities have not decreased at the same pace
as the decreases in yields on interest earning assets are that the Company has
more competitively priced its deposits to fund its strong loan growth and a
higher reliance on time deposits greater than $100,000 and borrowed funds, both
of which generally carry higher interest rates. In 1997, the average balance of
time deposits greater than $100,000 and borrowings comprised 12.6% of total
average interest-bearing liabilities. In 1998, this percentage increased to
15.7% and in 1999 the percentage further increased to 19.5%. The increase in the
reliance on time deposits greater than $100,000 and borrowed funds has been
necessary because of the need to fund the strong loan growth, the lower growth
rates of the other liabilities that have lower interest rates, and the strategy
to leverage the Company's branches discussed above.
Changes in total interest income and total interest expense result from
changes in both volumes and rates in the related earning asset and
interest-bearing liability categories. Table 3 shows the quantitative effects on
net interest income of the changes in volumes and rates experienced by the
Company. As discussed above and illustrated in Table 3, changes in volumes have
been the primary cause of changes in the amounts of interest income and interest
expense recorded by the Company.
See additional information regarding net interest income on page 24 in the
section entitled "Interest Rate Risk."
14
Provision for Loan Losses
The provision for loan losses charged to operations is an amount sufficient
to bring the allowance for loan losses to an estimated balance considered
adequate to absorb probable losses inherent in the portfolio. Management's
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, current economic conditions, historical loan loss experience and
other risk factors.
The Company made provisions for loan losses of $910,000 in 1999 compared to
$990,000 in 1998 and $575,000 in 1997. The changes in the provisions for loan
losses over the past three years have been primarily due to variances in new
loan volumes experienced, and not due to changes in the Company's asset quality.
Net loan growth in 1999 amounted to $60.8 million compared to $77.8 million in
1998. As discussed in the section entitled "Nonperforming Assets" below, asset
quality ratios for 1999 were very consistent with those for 1998. The Company's
$77.8 million in net loan growth in 1998 was substantially more than the $57.5
million originated in 1997 and resulted in the increase in the provision for
loan losses despite the improved asset quality ratios in 1998 compared to 1997.
See the section entitled "Allowance for Loan Losses and Loan Loss
Experience" below for a more detailed discussion of the allowance for loan
losses. The allowance is monitored and analyzed regularly in conjunction with
the Bank's loan analysis and grading program, and adjustments are made to
maintain an adequate allowance for loan losses.
Noninterest Income
Noninterest income recorded by the Company amounted to $5,121,000 in 1999,
$4,656,000 in 1998, and $4,150,000 in 1997.
The 10.0% increase in 1999 noninterest income compared to 1998 was driven
by a $677,000, or 15.4%, increase in the amount of core noninterest income
earned by the Company. Core noninterest income, which excludes gains and losses
from sales of securities, loans, and other assets, as well as nonrecurrring
items, increased from $4,405,000 in 1998 to $5,082,000 in 1999. The 12.2%
increase in total noninterest income from 1997 to 1998 was also driven largely
by an increase in core noninterest income. Core noninterest income increased
$387,000, or 9.6% in 1998 compared to 1997. Noninterest income not defined as
"core" amounted to a net of $39,000 in 1999, $251,000 during 1998, and $132,000
in 1997.
See Table 4 and the following discussion for an understanding of the
components of noninterest income.
Service charges on deposit accounts increased $240,000 or 9.2% in 1999
after increasing $182,000, or 7.5%, in 1998. The 1999 increase was due primarily
to a higher service fee schedule that was implemented in March 1999, as well as
an increase in deposit accounts. The 1998 increase was due to the growth in
deposits. However, excluding the effects of the higher fee schedule, service
charges on deposit accounts have not increased at the same rate as deposits over
the last two years. The Company believes that this is primarily due to the mix
of the Company's deposit growth. The growth in transaction accounts, which
includes demand, savings, and money market deposits and generates the majority
of these fees, has not been as great as the growth in time deposits, which have
fewer related fees. Additionally, the dollar increases that have occurred in the
outstanding balance of transaction accounts have been more heavily concentrated
in a fewer number of accounts with large balances as a result of the Company's
growth strategy discussed above.
Other service charges, commissions, and fees increased by $283,000, or
27.5% in 1999, after increasing by $259,000, or 33.7% in 1998. This category of
noninterest income includes items such as safety deposit box rentals, check
cashing fees, credit card and merchant income, and ATM surcharges. This category
of income grew primarily because of increases in these transaction-related fee
services as a result of overall growth in the Company's customer base. Increases
in fees earned from surcharges levied on non-customer ATM transactions, which
began in March 1998, also enhanced the growth in this category of income. ATM
surcharge revenue
15
amounted to $176,000 in 1999 and $142,000 in 1998, and is helping to defray the
significant capital investment and maintenance expense incurred on ATM machines.
Fees that the Company earns from presold mortgage loans grew by $85,000 in
1999, or 15.8% after increasing by $253,000, or 89.1% during 1998. The lower
interest rate environment experienced over the past two years, which has been
conducive to mortgage loan refinancings, was largely responsible for the
increase in these fees. Due to the rising interest rate environment toward the
end of 1999, the amount of these fees decreased substantially in the fourth
quarter of 1999 and lower levels of these fees will likely continue into the
year 2000.
Commissions from insurance sales increased by $24,000 in 1999 after
decreasing by $38,000 in 1998. The 1999 increase was due to a $24,000
"experience bonus" paid to the Company from the company that provides the credit
life insurance that the Company earns commissions from selling. This payment was
due to favorable loss experience on credit insurance policies that the Company
sold. The amount of this payment is computed annually and is dependent on the
amount of losses that result from policies that the Company sells and thus may
be more or less than the 1999 amount in future years. The Company did not
receive an experience bonus in 1998 or 1997. The $35,000 decrease in commissions
from insurance sales in 1997 was a result of lower commission fee rates
negotiated with brokers, as well as a higher percentage of the Company's
customers utilizing their home equity lines of credit to finance consumer
purchases versus obtaining consumer installment loans, where the Company has
typically sold more insurance policies.
Data processing fees amounted to $50,000 in 1999, $5,000 in 1998, and
$274,000 in 1997. As noted earlier, Montgomery Data makes its excess data
processing capabilities available to area financial institutions for a fee.
Montgomery Data had one nonaffiliated customer for the first eleven months of
1997, at which time the customer terminated its contract as a result of being
acquired by another institution. This customer was responsible for the $274,000
in data processing fees earned in 1997. Montgomery Data did not have any
nonaffiliated customers from December 1997 to December 1998. In December 1998, a
contract was signed to provide data processing for a nearby de novo bank. This
customer was charged $5,000 in December 1998 and $40,000 for the year of 1999 in
data processing services. In March 1999, Montgomery Data was contracted to
perform limited item processing services for another de novo bank in the area at
an annual rate that is currently approximately $12,000. Montgomery Data earned
$10,000 from this customer in 1999.
Noninterest income not defined as "core" amounted to a net of $39,000 in
1999, $251,000 during 1998, and $132,000 in 1997. The primary reason for the
variance between 1999 and 1998 was fewer gains from commercial loan sales.
During 1998, the Company sold approximately $6.4 million in newly originated
commercial loans that resulted in gains of $227,000. These sales were executed
primarily to manage the significant loan growth experienced in 1998, as well as
to maintain a proper balance between the amount of loans and deposits that the
Company maintains. In 1999, loan growth slowed and the Company did not believe
it was necessary to sell as many commercial loans as in 1998. In 1999, $3.7
million in commercial loan sales were made at a total gain of $34,000. In 1997,
noninterest income not classified as "core" was primarily comprised of an early
termination fee in the amount of $168,000 that Montgomery Data received from the
bank discussed above that terminated its data processing contract with
Montgomery Data prematurely.
Noninterest Expenses
Noninterest expenses for 1999 were $17,816,000, a 12.0% increase over the
1998 amount of $15,912,000. The 1998 amount was 12.9% higher than the
$14,088,000 incurred in 1997. Table 5 presents the components of the Company's
noninterest expense during the past three years.
The increases in noninterest expenses in the past two years occurred in
almost all categories and were due primarily to the Company's growth. The
Company incurred higher expenses in order to properly process, manage, and
service the 49% increase in loans and 33% increase in deposits that have
occurred over the past two years.
16
Personnel expense, the single largest component of noninterest expense,
increased 12.2% in 1999 and 15.3% during 1998. These increases were primarily
due to additional employees associated with the Company's growth, as well as
normal annual wage increases. The total number of employees of the Company
increased 6% in 1999 and 8% in 1998. Also included in noninterest expenses in
1999 are professional fees and other expenses totaling approximately $268,000
incurred in connection with the Company's 1999 formation of First Troy, a
subsidiary formed as a real estate investment trust that allows the Company to
centrally manage a portion of its residential, mortgage, and commercial real
estate loan portfolio.
Income Taxes
The provision for income taxes was $3,260,000 in 1999, $3,059,000 in 1998,
and $2,549,000 in 1997. The 6.6% increase in tax expense in 1999 compared to
1998 is a result of a 13.0% increase in pretax income, which was largely offset
by a decrease in the Company's effective tax rate from 35.0% in 1998 to 33.0% in
1999. The reduction in the effective tax rate for 1999 is largely due to the
favorable state tax treatment of the real estate investment trust (First Troy).
The 20% increase in tax expense in 1998 compared to 1997 is a result of a
16% increase in pretax income, as well as an increase in the Company's effective
tax rate from 33.7% in 1997 to 35.0% in 1998. The increase in the Company's
effective tax rate occurred as a result of the Company deriving a smaller
percentage of its earnings from tax-exempt securities.
Table 6 presents the components of tax expense and the related effective
tax rates.
ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION
The following discussion focuses on the factors considered by management to
be important in assessing the Company's financial condition. The Company's
assets and deposits continued strong growth rates that began in 1997, reflecting
growth in existing markets and expansion into new geographic areas. As
previously noted, over the past two years, the Company's loans have grown by
49.4% and deposits have grown by 32.9%. Growth rates over the past three years
have been 87.9% for loans and 61.2% for deposits.
Total assets were $559.4 million at December 31, 1999, an increase of 13.7%
over December 31, 1998. Assets during 1998 grew to $491.8 million at year end, a
22.1% increase over the $402.7 million at December 31, 1997. Interest-earning
assets amounted to $519.6 million at December 31, 1999, a 14.2% increase over
the amount at December 31, 1998. Interest-earning assets at December 31, 1998
were $454.9 million, an increase of 23.3% over the $369.0 million held at
December 31, 1997. Loans, the primary interest-earning asset, grew 17.0% in 1999
and 27.7% in 1998, with a total of $419.2 million at December 31, 1999.
Deposits were the primary funding source in 1999 and 1998 for the growth in
loans. Deposits increased 9.0%, or $39.8 million, during 1999, amounting to
$480.0 million at year end. In 1998, deposits grew 21.9%, or $79.0 million, to
$440.3 million at year end.
The Company's assets, loans, and deposits experienced compound annual
growth rates of approximately 14.1%, 17.7%, and 13.2%, respectively, over the
last five years ended December 31, 1999.
Distribution of Assets and Liabilities
Table 7 sets forth the percentage relationships of significant components
of the Company's balance sheets at December 31, 1999, 1998, and 1997. The most
significant variance in this table is the shift in asset mix over the past two
years from securities to loans that is primarily due to strong loan growth that
was partially funded with proceeds from securities maturities and sales.
17
Securities
Information regarding the Company's securities portfolio as of December 31,
1999, 1998, and 1997 is presented in Tables 8 and 9. Total securities available
for sale and held to maturity amounted to $71.8 million, $77.3 million, and
$71.1 million at December 31, 1999, 1998, and 1997, respectively. The decrease
in securities in 1999 was primarily due to two reasons - 1) the Company's
decision not to reinvest security paydowns and maturities during the last four
months of 1999 as part of the Company's Y2K liquidity plan and 2) security
proceeds were used to help fund loan growth, which exceeded deposit growth in
1999. Because of the uncertainty regarding possible increased customer
withdrawals of deposits due to Y2K fears, the Company's Y2K liquidity plan
called for, among other things, the Company not to reinvest proceeds from
security paydowns and maturities into additional securities, but rather to
invest the proceeds in highly liquid overnight interest-bearing accounts. The
second reason for the decrease in securities at year end was loan growth that
exceeded deposit growth, which required using securities to partially fund the
loan growth. As previously noted, loan growth during 1999 was $60.8 million
compared to deposit growth of $39.8 million.
The increase in securities at December 31, 1998 compared to December 31,
1997 was largely due to the Company purchasing approximately $19 million in
securities during the fourth quarter of 1998. Until the fourth quarter of 1998,
because of the relatively flat yield curve, the Company maintained its excess
cash in overnight investments. With the steepening of the yield curve that
occurred with the three successive 25 basis point rate cuts by the Federal
Reserve beginning in early October 1998, management of the Company purchased
securities to realize the higher yield that could be obtained from securities
versus overnight investments.
Average total securities were approximately $74.8 million during 1999
compared to $65.0 million during 1998 and $75.7 million in 1997. The higher
average balance in securities during 1999 was due to the effects of the $19
million in securities that the Company purchased in the fourth quarter of 1998.
The lower average balance in securities during 1998 compared to 1997 was due to
the Company holding more cash in overnight investments versus investing in
securities for most of the year for the reasons discussed above.
The composition of the securities portfolios at December 31, 1999 compared
to 1998 reflects the Company's decision not to reinvest proceeds received from
paydowns, calls, and maturities of the Company's mortgage-backed security
portfolio during the last four months of the year as part of the Company's Y2K
liquidity plan, as discussed above. Comparing 1998 to 1997 reflects a shift from
U.S. Treasuries and Government Agencies to higher yielding mortgage-backed
securities, including collateralized mortgage obligations. Included in
mortgage-backed securities at December 31, 1999 were collateralized mortgage
obligations with an amortized cost of $10,955,000 and a fair value of
$10,824,000. Included in mortgage-backed securities at December 31, 1998 were
collateralized mortgage obligations with an amortized cost of $16,656,000 and a
fair value of $16,620,000.
At December 31, 1999, net unrealized losses of $1,941,000 were included in
the carrying value of securities classified as available for sale compared to
net unrealized gains of $60,000 and $282,000 at December 31, 1998 and 1997,
respectively. The generally higher bond interest rate environment in effect at
each of the past two year ends has been the primary factor in the decline in the
fair value of the Company's available for sale securities compared to their
cost. Management evaluated any unrealized losses on individual securities at
each year end and determined them to be of a temporary nature and caused by
fluctuations in market interest rates, not by concerns about the ability of the
issuers to meet their obligations. Net unrealized gains (losses), net of
applicable deferred income taxes, of ($1,184,000), $37,000, and $186,000, have
been reported as a separate component of shareholders' equity as of December 31,
1999, 1998, and 1997, respectively.
The fair value of securities held to maturity, which the Company carries at
amortized cost, was less than the carrying value at December 31, 1999 by
$152,000, while their fair value exceeded their carrying value by $743,000 at
December 31, 1998, and $656,000 at December 31, 1997. Management evaluated any
unrealized losses on individual securities at each year end and determined them
to be of a temporary nature and caused by fluctuations in market interest rates,
not by concerns about the ability of the issuers to meet their obligations.
Table 9 provides detail as to scheduled contractual maturities and book
yields on securities available for sale
18
and securities held to maturity at December 31, 1999. Mortgage-backed securities
are shown in the time periods consistent with their estimated life based on
expected prepayment speeds. Approximately 77% of the available for sale
portfolio has a maturity date within 5 years. The weighted average life of the
available for sale portfolio using the maturity date for non-mortgage-backed
securities, and the expected life for mortgage-backed securities, was 4.1 years.
In the rate environment in effect at December 31, 1999, none of the Company's
callable bonds in the available for sale portfolio are expected to be called,
and thus the expected life of the portfolio is also 4.1 years. The weighted
average taxable-equivalent yield for the securities available for sale portfolio
was 6.06% at December 31, 1999.
The weighted average life of the securities held to maturity portfolio
based on maturity dates was 5.9 years at December 31, 1999 with a weighted
average taxable-equivalent yield of 7.53%. If above-market callable bonds are
assumed to be called on their call date, the weighted average maturity of the
held to maturity portfolio drops slightly to 5.7 years.
As of December 31, 1999 and 1998, the Company held no investment securities
of any one issuer, other than U.S. Treasury and U.S. Government agencies or
corporations, in which aggregate book values and market values exceeded 10% of
shareholders' equity. Other than the collateralized mortgage obligations
previously discussed, the Company owned no securities considered by regulatory
authorities to be derivative instruments.
Loans
Table 10 provides a summary of the loan portfolio composition at each of
the past five year ends.
Loans increased by $60.8 million, or 17.0%, in 1999 to $419.2 million from
the $358.3 million held at December 31, 1998. The 1998 year end amount was $77.8
million, or 27.7%, higher than the $280.5 million balance at December 31, 1997.
The majority of the 1999 and 1998 loan growth occurred in loans secured by
real estate, with approximately $54.3 million, or 89.2% in 1999 and $69.1
million, or 88.9%, in 1998 of the net loan growth occurring in real estate
mortgage or real estate construction loans. In 1999, real estate mortgage loans
grew 24.3%, real estate construction loans decreased 9.8%, commercial,
financial, and agricultural (CF&A) loans grew 11.7%, and installment loans to
individuals grew 1.5%. In 1998, real estate mortgage loans grew 27.9%, real
estate construction loans grew 89.2%, CF&A loans grew 15.4%, and installment
loans to individuals grew 5.6%. For four out of the past five years, CF&A loans
have comprised a lower percentage of the loan portfolio, and for five straight
years, installment loans to individuals have decreased in relation to the
overall portfolio. As discussed above in the section entitled "Net Interest
Income", this shift from non-real estate to real estate loans has been partially
due to a strategic shift towards higher dollar loans, which tend to be secured
by real estate in most cases, in order to more quickly leverage the Bank's
balance sheet and branch network. As noted earlier, the shift to a higher
percentage of real estate loans has contributed to the decrease in the Bank's
loan yields and net interest margin, as real estate loans generally carry lower
interest rates than non-real estate loans.
A large portion of the Company's loan portfolio has historically been
comprised of loans secured by various types of real estate. At December 31,
1999, $328.7 million or 78.38% of the Company's loan portfolio was secured by
liens on real property. Included in this total are $157.6 million, or 37.6% of
total loans, in credit secured by liens on 1-4 family residential properties and
$171.1 million, or 40.8% of total loans, in credit secured by liens on other
types of real estate.
Table 11 provides a summary of scheduled loan maturities over certain time
periods, with fixed rate loans and adjustable rate loans shown separately.
Approximately 30% of the Company's loans outstanding at December 31, 1999 mature
within one year and 82% of total loans mature within five years. These
percentages are approximately the same as they were at December 31, 1998. The
percentages of variable rate loans and fixed rate loans as compared to total
performing loans were 41.4% and 58.6%, respectively, as of December 31, 1999
compared to 46.5% and 53.5%, respectively, as of December 31, 1998. The Company
intentionally makes a blend of fixed and
19
variable rate loans so as to reduce interest rate risk. The yield on performing
loans as of December 31, 1999 was 8.79% compared to 8.63% at December 31, 1998
and 9.23% at December 31, 1997. The increase in the yield at December 31, 1999
compared to a year earlier is due to an increase in the prime rate of interest
of 75 basis points during 1999. The lower yield at December 31, 1998 compared to
December 31, 1997 is primarily due to a 75 basis point lowering of the prime
rate during 1998. Both years were affected by the Company's general trend,
beginning in the second half of 1997, of originating larger balance real estate
loans with slightly lower yields as discussed previously.
See additional information regarding interest rate risk on page 24 in the
section entitled "Interest Rate Risk."
Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans past due 90 or
more days and still accruing interest, restructured loans and other real estate.
As a matter of policy the Company places all loans that are past due 90 or more
days on nonaccrual basis, and thus there were no such loans at any of the past
five year ends that were 90 days past due and still accruing interest. Table 12
summarizes the Company's nonperforming assets at the dates indicated.
Nonaccrual loans are loans on which interest income is no longer being
recognized or accrued because management has determined that the collection of
interest is doubtful. The placing of loans on nonaccrual status negatively
impacts earnings because (i) interest accrued but unpaid as of the date a loan
is placed on nonaccrual status is either deducted from interest income or is
charged-off, (ii) future accruals of interest income are not recognized until it
becomes highly probable that both principal and interest will be paid and (iii)
principal charged-off, if appropriate, may necessitate additional provisions for
loan losses that are charged against earnings. In some cases, where borrowers
are experiencing financial difficulties, loans may be restructured to provide
terms significantly different from the originally contracted terms.
Nonperforming loans (which includes nonaccrual loans and restructured
loans) as of December 31, 1999, 1998 and 1997 totaled $852,000, $849,000, and
$1,283,000, respectively. Nonperforming loans as a percentage of total loans
amounted to 0.20%, 0.24%, and 0.46%, at December 31, 1999, 1998, and 1997,
respectively. Although the amount of nonperforming loans at December 31, 1999 of
$852,000 is almost the same as the $849,000 from a year earlier, as it relates
to the nonaccrual loans, virtually all of the borrowers comprising the
nonaccrual balance are different between the two year ends, reflecting the
resolution of 1998's nonaccrual loans via payoff, charge-off, or return to
accrual status. The decrease in nonperforming loans from 1997 to 1998 was
primarily due to improved overall loan quality, as well as the pay-out of a
$230,000 loan in the first quarter of 1998 that was on nonaccrual status at
December 31, 1997. The decrease in nonperforming loans at December 31, 1997 as
compared to December 31, 1996 is primarily attributable to the resolution of
several relationships that resulted in partial charge-offs during the year, as
well as generally improved loan quality. The increase in nonperforming loans at
December 31, 1996 compared to December 31, 1995 was largely due to $1,300,000
more in loans on nonaccrual status that were assumed in corporate acquisitions
occurring in 1994 and 1995. These nonaccrual loans that were originated by other
institutions amounted to $1,461,000 at December 31, 1996 compared to $161,000 at
December 31, 1995. As of December 31, 1999, the largest nonaccrual balance to
any one borrower was $124,000, with the average balance for the 23 nonaccrual
loans being approximately $26,000.
If the nonaccrual loans and restructured loans as of December 31, 1999,
1998 and 1997 had been current in accordance with their original terms and had
been outstanding throughout the period (or since origination if held for part of
the period), gross interest income in the amounts of approximately $58,000,
$60,000 and $91,000 for nonaccrual loans and $27,000, $25,000 and $34,000 for
restructured loans would have been recorded for 1999, 1998 and 1997,
respectively. Interest income on such loans that was actually collected and
included in net income in 1999, 1998 and 1997 amounted to approximately $22,000,
$22,000 and $32,000 for nonaccrual loans (prior to their being placed on
nonaccrual status) and $24,000, $24,000 and $25,000 for restructured loans,
respectively.
In addition to the nonperforming loan amounts included above, management
believes that an estimated
20
$1,000,000-$1,500,000 of loans that are currently performing in accordance with
their contractual terms may potentially develop problems depending upon the
particular financial situations of the borrowers and economic conditions in
general. Management has taken these potential problem loans into consideration
when evaluating the adequacy of the allowance for loan losses at December 31,
1999 (see discussion below).
Loans classified for regulatory purposes as loss, doubtful, substandard, or
special mention that have not been disclosed in the problem loan amounts and the
potential problem loan amounts discussed above do not represent or result from
trends or uncertainties which management reasonably expects will materially
impact future operating results, liquidity, or capital resources, or represent
material credits about which management is aware of any information which causes
management to have serious doubts as to the ability of such borrowers to comply
with the loan repayment terms.
Other real estate includes foreclosed, repossessed, and idled properties.
Other real estate totaled $906,000 at December 31, 1999 compared to $505,000 at
December 31, 1998, and $560,000 at December 31, 1997. Other real estate
represented 0.16%, 0.10%, and 0.14% of total assets at the end of 1999, 1998,
and 1997, respectively. The increase in the level of other real estate at
December 31, 1999 when compared to the prior two year ends primarily relates to
the reclassification of two bank branches that were closed during 1999 from
premises and equipment to other real estate. The Company's management has
reviewed recent appraisals of its other real estate and believes that their fair
values, less estimated costs to sell, exceed their respective carrying values at
the dates presented.
Allowance for Loan Losses and Loan Loss Experience
The allowance for loan losses is created by direct charges to operations.
Losses on loans are charged against the allowance in the period in which such
loans, in management's opinion, become uncollectible. The recoveries realized
during the period are credited to this allowance.
The factors that influence management's judgment in determining the amount
charged to operating expense include past loan loss experience, composition of
the loan portfolio, evaluation of probable inherent losses and current economic
conditions.
The Company uses a loan analysis and grading program to facilitate its
evaluation of probable inherent loan losses and the adequacy of its allowance
for loan losses. In this program, risk grades are assigned by management and
tested by the Company's Internal Audit Department and an independent third party
consulting firm. The testing program includes an evaluation of a sample of new
loans, loans that management identifies as having potential credit weaknesses,
loans past due 90 days or more, nonaccrual loans and any other loans identified
during previous regulatory and other examinations.
.
The Company strives to maintain its loan portfolio in accordance with what
management believes are conservative loan underwriting policies that result in
loans specifically tailored to the needs of the Company's market areas. Every
effort is made to identify and minimize the credit risks associated with such
lending strategies. The Company has no foreign loans, few agricultural loans and
does not engage in significant lease financing or highly leveraged transactions.
Commercial loans are diversified among a variety of industries. The majority of
loans captioned in the tables discussed below as "real estate" loans are
primarily various personal and commercial loans where real estate provides
additional security for the loan. Collateral for virtually all of these loans is
located within the Company's principal market area.
The allowance for loan losses amounted to $6,078,000 at December 31, 1999
compared to $5,504,000 as of December 31, 1998 and $4,779,000 at December 31,
1997. This represented 1.45%, 1.54%, and 1.70%, of loans outstanding as of
December 31, 1999, 1998, and 1997, respectively. The allowance for loan losses
as a percentage of total loans has been gradually decreasing since its high of
2.81% at September 30, 1994. The September 30, 1994 high of 2.81% was an
increase from the 1.79% ratio at June 30, 1994 due primarily to an addition to
the allowance of $2.5 million that was recorded in the third quarter of 1994 in
connection with a corporate acquisition in which a higher risk loan portfolio
was acquired. The general decrease in the ratio of allowance for loan losses to
21
total loans since then has been largely due to charge-offs associated with that
portfolio, strong recent loan growth, as well as generally improved overall loan
quality. As noted in Table 12, the Company's allowance for loan losses as a
percentage of nonperforming loans amounted to 713.38% at December 31, 1999,
compared to 648.29% at December 31, 1998 and 372.49% at December 31, 1997.
Table 13 sets forth the allocation of the allowance for loan losses at the
dates indicated. The portion of these reserves that was allocated to specific
loan types in the loan portfolio increased from $4,220,000 at December 31, 1998
to $4,647,000 at December 31, 1999. The December 31, 1998 allocated amount of
$4,220,000 was an increase from the December 31, 1997 amount of $3,789,000. The
increase in the allocated amounts for both years was primarily due to growth in
the Company's loan portfolio. In addition to the allocated portion of the
allowance for loan losses, the Company maintains an unallocated portion that is
not assigned to any specific category of loans, but rather is intended to
reserve for the inherent risk in the overall portfolio and the intrinsic
inaccuracies associated with the estimation of the allowance for loan losses and
its allocation to specific loan categories. The general increase in the
unallocated portion of the allowance for loan losses has been consistent with
overall loan growth.
Management considers the allowance for loan losses adequate to cover
probable loan losses on the loans outstanding as of each reporting date. It must
by emphasized, however, that the determination of the allowance using the
Company's procedures and methods rests upon various judgments and assumptions
about economic conditions and other factors affecting loans. No assurance can be
given that the Company will not in any particular period sustain loan losses
that are sizable in relation to the amount reserved or that subsequent
evaluations of the loan portfolio, in light of conditions and factors then
prevailing, will not require significant changes in the allowance for loan
losses or future charges to earnings.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowances for loan losses and
losses on foreclosed real estate. Such agencies may require the Company to
recognize additions to the allowances based on the examiners' judgments about
information available to them at the time of their examinations.
For the years indicated, Table 14 summarizes the Company's balances of
loans outstanding, average loans outstanding, changes in the allowance arising
from charge-offs and recoveries by category, and additions to the allowance that
have been charged to expense. The Company's net loan charge offs were
approximately $336,000 in 1999, $265,000 in 1998, and $522,000 in 1997. This
represents 0.09%, 0.08%, and 0.21% of average loans during 1999, 1998, and 1997,
respectively.
Deposits
The average amounts of deposits of the Company for the years ended December
31, 1999, 1998 and 1997 are presented in Table 15. Average deposits grew $56.7
million or 14.3% in 1999 to $453.6 million. Average deposits for 1998 grew by
23.8% over the 1997 average to $397.0 million.
Average time deposits greater than $100,000 have experienced the highest
percentage growth of any of the deposit categories in each of the past two
years. In 1999, average time deposits greater than $100,000 increased $16.3
million or 31.4%, while in 1998 these deposits increased $17.0 million, or
48.6%. The primary reason for the high growth within this category of deposits
is that the Company began more competitively pricing this category of deposits
in order to help fund the strong loan growth experienced both years and to
leverage the branch network, as has been discussed previously. The Company also
priced time deposits greater than $100,000 especially competitively toward the
end of 1999 in order to provide funding for potential Y2K related withdrawals.
While not as high as the growth rates of time deposits greater than $100,000,
the growth in the other categories of deposits has been strong over the past two
years. Average interest-bearing demand deposits increased 12.4% in 1999 and
17.4% in 1998. Average savings deposits increased 15.3% in 1999 and 19.9% in
1998. Average interest-bearing time deposits increased 11.4% in 1999 and 23.4%
in 1998. Average noninterest-bearing demand deposits increased 8.5% in 1999 and
21.1% in 1998.
22
The Company's growth in deposits did not keep pace with its growth in loans
during 1999. Comparing year ends, total loan growth in 1999 was $60.8 million,
while deposit growth was $39.8 million. The Company attributes this trend
partially to Y2K deposit withdrawals or non-deposits. However, the Company also
believes that due to increased competition from sources that can more easily
take deposits than can originate loans (such as brokerage houses, internet
banks, and the stock market in general), this trend is likely to continue.
Accordingly, the Company anticipates that in order to continue to provide
funding for loan growth, rates paid on deposits will continue to rise in
comparison to the general market, and alternative funding sources such as
long-term borrowings may be necessary.
As noted in the net interest income section above, the average yield on the
Company's interest-bearing deposits did not decrease in 1999 as much as the
average interest rate environment in general. This is primarily due to the
Company having a higher mix of time deposits greater than $100,000 for the
reasons noted above. The average rates paid in the various individual deposit
categories in 1999 generally tracked the lower market interest rates in effect
during most of 1999 compared to 1998. The average interest rate paid on
interest-bearing demand deposits decreased 41 basis points during 1999 from
2.23% to 1.82%. The average interest rate paid on savings accounts decreased
only 13 basis points during 1999 to 2.34% from 2.47% in 1998. This lower rate of
decrease in the average rate paid is associated with this category achieving a
majority of its growth in the highest rate savings account that the Company
offers - the preferred savings account. The average rate paid on time deposits
decreased 32 basis points in 1999 from 5.34% to 5.02%, while the average rate
paid on time deposits greater than $100,000 decreased 40 basis points in 1999,
from 5.91% to 5.51%.
In 1998, despite a slightly lower interest rate environment compared to
1997, three of the four categories of interest-bearing deposits experienced
increases in the average rates paid and the fourth, interest-bearing demand
deposits, only experienced a 4 basis point decrease. This was largely due to two
reasons - 1) the Company priced all of its deposits more competitively in an
attempt to fund the significant loan growth experienced in 1998, and 2) as it
relates to the interest-bearing demand deposits and the savings deposits
categories, the majority of the growth within these two categories was within
the highest yielding account types within these categories.
The Company has a large, stable base of time deposits with little
dependence on volatile public deposits of $100,000 or more. The time deposits
are principally certificates of deposit and individual retirement accounts
obtained from individual customers. Deposits of local governments and municipal
entities represented 3.9% of the Company's total deposits at December 31, 1999.
All such public funds are collateralized by investment securities. The Company
does not purchase brokered deposits.
As of December 31, 1999, the Company held approximately $81,831,000 in time
deposits of $100,000 or more and other time deposits of $173,319,000. Table 16
is a maturity schedule of time deposits of $100,000 or more as of December 31,
1999. This table shows that 85.4% of the Company's time deposits greater than
$100,000 mature within one year.
23
Borrowings
The Company has three sources of borrowing capacity - 1) an approximately
$62,000,000 line of credit with the Federal Home Loan Bank (FHLB), 2) a
$15,000,000 overnight federal funds line of credit with a correspondent bank,
and 3) an approximately $27,000,000 line of credit through the Federal Reserve
Bank of Richmond's (FRB) discount window. The Company did not obtain any
long-term borrowings under these any of these credit lines during 1999, 1998 or
1997.
The Company's line of credit with the FHLB totaling approximately
$62,000,000 can be structured as either short-term or long-term borrowings,
depending on the particular funding or liquidity need, and is secured by the
Company's FHLB stock and a blanket lien on its one-to-four family residential
loan portfolio. During 1999 and 1998, the Company periodically used this line of
credit as a short-term, overnight borrowing to meet internally targeted
liquidity levels that carried an interest rate that was approximately 25 basis
points higher than the national discount rate. In addition, on October 29, 1999,
the Company obtained a three month $15,000,000 borrowing from the FHLB at a
fixed interest rate of 5.98% in connection with the Company's Y2K liquidity
plan. At December 31, 1999, a total of $30,000,000 was outstanding under the
FHLB line of credit, $15,000,000 of which was the three month borrowing at 5.98%
and $15,000,000 which was an overnight, adjustable rate borrowing that had an
interest rate of 4.55% on December 31, 1999. There was no amount outstanding
under this line of credit at December 31, 1998 or 1997.
The Company also has a correspondent bank relationship established that
allows the Company to purchase up to $15,000,000 in federal funds on an
overnight, unsecured basis. The Company had no borrowings under this line at
December 31, 1999. At December 31, 1998, the Company had $6,000,000 outstanding
under this arrangement at an interest rate of approximately 5.25%.
During 1999, the Company established a line of credit totaling
approximately $27,000,000 with the FRB discount window. This line is secured by
a blanket lien on a portion of the Company's commercial, consumer and real
estate portfolio (not including 1-4 family). This line of credit was established
primarily in connection with the Company's Y2K liquidity contingency plan. This
line of credit was not drawn on during 1999, and subsequent to December 31,
1999, the FRB has stated that it does not expect lines of credit that have been
granted to financial institutions to be a primary borrowing source. The Company
plans to maintain this line of credit, although it is not expected that it will
be drawn upon except in unusual circumstances.
The total amount of average borrowings was $11,211,000 in 1999 compared to
$2,523,000 in 1998 and $55,000 in 1997. The general increase in the amount of
borrowings that the Company has had outstanding has been associated with strong
loan growth that the Company has experienced, which has outpaced deposit growth.
As noted in "Deposits" above, the Company expects it to be increasingly
difficult to fund all loan growth with deposits. Accordingly, the Company
expects average borrowings to continue to increase. Additionally, in the future
the Company may structure a portion of its borrowings as long-term depending on
market conditions.
Interest Rate Risk (Including Quantitative and Qualitative Disclosures
About Market Risk - Item 7A.)
Net interest income is the Company's most significant component of
earnings. Notwithstanding changes in volumes of loans and deposits, the
Company's level of net interest income is continually at risk due to the effect
that changes in general market interest rate trends have on interest yields
earned and paid with respect to the various categories of earning assets and
interest-bearing liabilities. It is the Company's policy to maintain portfolios
of earning assets and interest-bearing liabilities with maturities and repricing
opportunities that will afford protection, to the extent practical, against wide
interest rate fluctuations. The Company's exposure to interest rate risk is
analyzed on a regular basis by management using standard GAP reports, maturity
reports, and an asset/liability software model that simulates future levels of
interest income and expense based on current interest rates, expected future
interest rates, and various intervals of "shock" interest rates. Over the years,
the Company has been able to maintain a fairly consistent yield on average
earning assets (net interest margin). Over the past ten years the net interest
margin has not varied in any single calendar year by more than the 41 basis
point
24
change experienced by the Company in 1998, and the lowest net interest margin
realized over that same period is within 65 basis points of the highest.
Table 17 sets forth the Company's interest rate sensitivity analysis as of
December 31, 1999, using stated maturities for all instruments except
mortgage-backed securities which are shown as a lump sum in the period
consistent with their weighted average estimated life. As illustrated by this
table, the Company has $147.8 million more in interest-bearing liabilities that
are subject to interest rate changes within one year than earning assets. This
generally would indicate that net interest income would experience downward
pressure in a rising interest rate environment and would benefit from a
declining interest rate environment. However, this method of analyzing interest
sensitivity only measures the magnitude of the timing differences and does not
address earnings, market value, or management actions. Also, interest rates on
certain types of assets and liabilities may fluctuate in advance of changes in
market interest rates, while interest rates on other types may lag behind
changes in market rates. In addition to the effects of "when" various
rate-sensitive products reprice, market rate changes may not result in uniform
changes in rates among all products. For example, included in interest-bearing
liabilities at December 31, 1999 subject to interest rate changes within one
year are deposits totaling $164.3 million comprised of NOW, savings, and certain
types of money market deposits with interest rates set by management. These
types of deposits historically have not repriced coincidentally with or in the
same proportion as general market indicators. Thus, the Company believes that
near term net interest income would not likely experience significant downward
pressure from rising interest rates. Similarly, management would not expect a
significant increase in near term net interest income from falling interest
rates. In fact, as discussed below, management believes the opposite to be true,
that the recent short-term effects of a rising interest rate environment have
generally had a positive impact on the Company's net interest income and that
the near term effects of a decrease in rates would generally have a negative
effect on net interest income. The Company has relatively little long-term
interest rate exposure, with approximately 85% of interest-earning assets
subject to repricing within five years and all interest-bearing liabilities
subject to repricing within five years.
The net interest margin for the fourth quarter of 1999 was 4.88% and
for the year of 1999 it was 5.01%. However, the fourth quarter ratio was
impacted by approximately 20 basis points and the percentage for the year was
impacted by approximately 5 basis points as a result of the Company's Y2K
liquidity plan, which called for the Company to increase its short-term
borrowings in order to provide more immediate liquidity to fund potentially high
rates of deposit withdrawals. The 20 and 5 basis point amounts only consider the
effects of the additional borrowings on the net interest margin and do not
include the related impact on the net interest margin of pricing the Company's
time deposits and time deposits greater than $100,000 more aggressively in order
to enhance liquidity. The remainder of this analysis will discuss the net
interest margin in terms of 5.08% for the fourth quarter of 1999 and 5.06% for
the year of 1999, the margins the Company believes it would have experienced if
not for the Y2K liquidity plan.
See additional discussion regarding net interest income, as well as
discussion of the changes in the annual net interest margin in the section
entitled "Net Interest Income" above. The following paragraph includes a more
detailed discussion of recent changes in interest rates and the impact that they
have had on the Company's quarterly net interest margin.
In the fourth quarter of 1998, the prime rate of interest decreased by 75
basis points. As of September 30, 1998 and December 31, 1998, although the
Company was liability sensitive in the "3 months or less" horizon, the Company
was significantly more liability sensitive in the "3 to 12 month" horizon, which
reflects maturities of the Company's significant time deposit portfolio. The
primary impact of the decrease in prime rate on the Company's interest earning
assets was that all of the Company's approximately $167 million in adjustable
rate loans (as of September 30, 1998) immediately repriced downward by 75 basis
points. On the interest-bearing liabilities side, the component of the Company's
interest bearing liabilities that reprice within three months were primarily the
Company's low interest-bearing deposits - interest-bearing savings, NOW, and
money market deposits - which the Company was not able to reprice downward by
the full 75 basis points. The effect of the different impact that the decrease
in rates had on the Company's assets and liabilities resulted in the Company's
net interest margin initially going down. In the third quarter of 1998, the
Company's net interest margin was 5.14%, while in the fourth
25
quarter of 1998, the net interest margin decreased to 5.03% and in the first
quarter of 1999 the net interest margin further decreased to 4.97%. In the
second quarter of 1999, the Company began to experience the positive effects
that the repricing at lower rates of the Company's time deposit portfolio had on
the net interest margin. The second quarter of 1999 net interest margin
increased to 5.04%. In the third quarter of 1999, the Company continued to
experience the positive effects of the time deposit repricing, and additionally
the prime rate of interest increased by 50 basis points. The general effect of
these increases in interest rates was the opposite of the negative consequences
experienced from the rate cuts discussed above - the Company's adjustable rate
loans immediately repriced by the full 50 basis points, while the Company was
able to maintain a relatively static average rate paid on deposits. These
factors resulted in the Company's net interest margin increasing to 5.16% in the
third quarter of 1999. The decrease in net interest margin to the adjusted 5.08%
in the fourth quarter of 1999 was largely due to a higher percentage of the
Company's deposits being comprised of time deposits greater than $100,000, the
category of deposits that pays the highest rate of interest.
Over the past six quarters, the Company's net interest margin, as adjusted,
has not varied from one quarter to the next by more than 16 basis points, and
the highest net interest margin over those six quarters is within 20 basis
points of the lowest net interest margin over the same time frame. While the
Company can not guarantee stability in its net interest margin in the future, at
this time management does not expect significant fluctuations. However, assuming
a static interest rate environment, the Company does expect that its net
interest margin will continue to experience gradual pressure because of
continued difficulties expected in growing deposits at their historical rate
spreads and at rates sufficient to fund loan growth, which could result in
additional reliance on borrowings (which generally carry higher rates than
deposits). See additional discussion in the section entitled "Deposits" above.
The Company has no market risk sensitive instruments held for trading
purposes, nor does it maintain any foreign currency positions. Table 18 presents
the expected maturities of the Company's other than trading market risk
sensitive financial instruments. Table 18 also presents the fair values of
market risk sensitive instruments as estimated in accordance with Statement of
Financial Accounting Standards No. 107, "Disclosures About Fair Value of
Financial Instruments." The Company's fixed rate earning assets have estimated
fair values that are slightly lower than their carrying value. This is due to
the yields on these portfolios being slightly lower than market yields at
December 31, 1999 for instruments with maturities similar to the remaining term
of the portfolios, due to a generally increasing interest rate environment at
year end. The estimated fair value of the Company's time deposits is higher than
its book value due to the highly competitive deposit rates the Company offered
in the fourth quarter of 1999 to fund loan growth and prepare for possible Y2K
withdrawals.
Off-Balance Sheet Risk
In the normal course of business there are various outstanding commitments
and contingent liabilities such as commitments to extend credit, which are not
reflected in the financial statements. As of December 31, 1999, the Company had
outstanding loan commitments of $96,385,000, of which $80,162,000 were at
variable rates and $16,223,000 were at fixed rates. Included in outstanding loan
commitments were unfunded commitments of $36,137,000 on revolving credit plans,
of which $31,799,000 were at variable rates and $4,338,000 were at fixed rates.
Additionally, standby letters of credit of approximately $2,332,000 and $924,000
were outstanding at December 31, 1999 and 1998, respectively. The Company's
exposure to credit loss for the aforementioned commitments in the event of
nonperformance by the party to whom credit or financial guarantees have been
extended is represented by the contractual amount of the financial instruments
discussed above. However, management believes that these commitments represent
no more than the normal lending risk that the Company commits to its borrowers.
If these commitments are drawn, the Company plans to obtain collateral if it is
deemed necessary based on management's credit evaluation of the counter-party.
The types of collateral held varies but may include accounts receivable,
inventory and commercial or residential real estate. Management expects any
draws under existing commitments to be funded through normal operations.
Off-balance-sheet derivative financial instruments include futures,
forwards, interest rate swaps, options contracts, and other financial
instruments with similar characteristics. The Company does not engage in
off-balance-sheet derivatives activities.
26
Return On Assets And Equity
Table 19 shows return on assets (net income divided by average total
assets), return on equity (net income divided by average shareholders' equity),
dividend payout ratio (dividends declared per share divided by net income per
share) and shareholders' equity to assets ratio (average shareholders' equity
divided by average total assets) for each of the years in the three-year period
ended December 31, 1999.
Liquidity
The Company's liquidity is determined by its ability to convert assets to
cash or acquire alternative sources of funds to meet the needs of its customers
who are withdrawing or borrowing funds, and to maintain required reserve levels,
pay expenses and operate the Company on an ongoing basis. The Company's primary
liquidity sources are net income from operations, cash and due from banks,
federal funds sold and other short-term investments. The Company's securities
portfolio is comprised almost entirely of readily marketable securities which
could also be sold to provide cash.
In addition to internally generated liquidity sources, the Company has the
ability to obtain borrowings from the following three sources - 1) an
approximately $62,000,000 line of credit with the Federal Home Loan Bank (FHLB),
2) a $15,000,000 overnight federal funds line of credit with a correspondent
bank, and 3) an approximately $27,000,000 line of credit through the Federal
Reserve Bank of Richmond's discount window. See the section above entitled
"Borrowings" for additional detail about these credit lines.
Although the Company has not historically had to rely on these sources of
credit as a source of liquidity, the Company has experienced an increase in its
loan to deposit ratio over the past three years, from 74.9% at December 31, 1996
to 77.7% at December 31, 1997 to 81.4% at December 31, 1998 to 87.3% at December
31, 1999, as a result of the significant loan growth experienced. This strong
loan growth has reduced the Company's liquidity sources. Beginning in the third
quarter of 1998, although the Company did not have any liquidity or funding
difficulties, the Company began making periodic draws and repayments on its
lines of credit, predominantly on an overnight basis to maintain liquidity
ratios at internally targeted levels. As noted in the section entitled
"Deposits" above, the Company expects to increasingly rely on its available
lines of credit in the future due to anticipation of continued difficulty in
funding new loan growth solely with deposits.
The Company's management believes its liquidity sources are at an
acceptable level and remain adequate to meet its operating needs.
Capital Resources
The Company is regulated by the Board of Governors of the Federal Reserve
Board (FED) and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Company's banking
subsidiary is regulated by the Federal Deposit Insurance Corporation (FDIC) and
the North Carolina Office of the Commissioner of Banks. The Company is not aware
of any recommendations of regulatory authorities or otherwise which, if they
were to be implemented, would have a material effect on its liquidity, capital
resources, or operations.
The Company must comply with regulatory capital requirements established by
the FED and FDIC. 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 Company's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company must meet specific capital
guidelines that involve quantitative measures of the Company's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Company's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. These capital standards require the Company to
maintain minimum ratios of "Tier 1" capital to total
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risk-weighted assets and total capital to risk-weighted assets of 4.00% and
8.00%, respectively. Tier 1 capital is comprised of total shareholders' equity
calculated in accordance with generally accepted accounting principles,
excluding accumulated other comprehensive income (loss), less intangible assets,
and total capital is comprised of Tier 1 capital plus certain adjustments, the
largest of which for the Company is the allowance for loan losses. Risk-weighted
assets refer to the on- and off-balance sheet exposures of the Company, adjusted
for their related risk levels using formulas set forth in FED and FDIC
regulations.
In addition to the risk-based capital requirements described above, the
Company is subject to a leverage capital requirement, which calls for a minimum
ratio of Tier 1 capital (as defined above) to quarterly average total assets of
3.00% to 5.00%, depending upon the institution's composite ratings as determined
by its regulators. The FED has not advised the Company of any requirement
specifically applicable to it.
In addition to the minimum capital requirements