U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2001
-----------------
[ ] Transition Report Under Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
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Commission file number 0-13086
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FNB Financial Services Corporation
202 South Main Street
Reidsville, North Carolina 27320
(336) 342-3346
Incorporated in the State of North Carolina
IRS Employer Identification No. 56-1382275
Securities Registered Pursuant to Section 12(b) of the Exchange Act:
None
Securities Registered Pursuant to Section 12(g) of the Exchange Act:
Common Stock, Par Value $1.00 Per Share
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers in response
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ X ]
The aggregate market value of the registrant's Common Stock at March
12, 2002, held by those persons deemed by the registrant to be non-affiliates,
based on the average bid and asked price of the Common Stock on that day, was
approximately $59.3 million.
As of March 12, 2002, (the most recent practicable date), the
registrant had outstanding 4,589,082 shares of Common Stock, $1.00 per value.
Documents Incorporated By Reference
Document Where Incorporated
-------- ------------------
1. Proxy Statement for the Annual Meeting of Shareholders Part III
to be held May 16, 2002 to be mailed to shareholders
within 120 days of December 31, 2001.
FNB Financial Services Corporation
Form 10-K
Table of Contents
Index Page
- ----- ----
PART I
Item 1. Business.................................................. 1
Item 2. Properties................................................ 18
Item 3. Legal..................................................... 19
Item 4. Submission of Matters to a Vote of Security Holders....... 19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters ................................. 20
Item 6. Selected Financial Data................................... 20
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations..... 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 30
Item 8. Financial Statements and Supplementary Data............... 41
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............... 67
PART III
Item 10. Directors and Executive Officers of the Registrant........ 67
Item 11. Executive Compensation.................................... 67
Item 12. Security Ownership of Certain Beneficial Owners
and Management....................................... 67
Item 13. Certain Relationships and Related Transactions............ 67
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K.......................................... 68
PART I
Item 1. Business
General
FNB Financial Services Corporation (the "Company") is a North
Carolina financial holding company with consolidated assets of $704.8 million,
deposits of $586.8 million and shareholders' equity of $62.7 million, each as of
December 31, 2001. The Company was organized in 1984 as a North Carolina bank
holding company, although its predecessor and wholly-owned subsidiary, FNB
Southeast (the "Bank" or "Subsidiary Bank"), opened as Rockingham Savings Bank
and Trust in 1910, and was then chartered as a national bank in 1918 under the
name of First National Bank of Reidsville. In May 1997, the Bank changed its
name to First National Bank Southeast to reflect its expansion into new markets.
Effective March 15, 1999, the Bank changed its charter from a national bank to a
North Carolina state bank and changed its name to FNB Southeast. The Company
filed an election with the Federal Reserve Board to become a financial holding
company on January 23, 2001, and became a financial holding company effective
February 12, 2001, under the Gramm-Leach-Bliley Act. A financial holding company
is permitted to engage in activities that are financial in nature or incidental
to a financial activity. The permitted activities of a financial holding company
are broader than for a bank holding company.
Historically, the Company has served the Rockingham County area of
North Carolina through three branches in Reidsville and two in Eden, North
Carolina. In 1995, the Company initiated a strategic growth plan beginning with
the hiring of a new chief executive officer. On August 31, 1999, the Company
acquired Black Diamond Savings Bank, FSB ("Black Diamond"), a federal savings
bank headquartered in Norton, Virginia. By the end of 2001, FNB Southeast had
increased its number of North Carolina branches from five to thirteen by closing
a branch in Eden and opening nine new branches in the Rockingham County towns of
Eden, Ruffin and Madison and in the new markets of Greensboro, Burgaw and
Wilmington. The acquisition of Black Diamond added branches in Norton,
Harrisonburg, Pennington Gap and Richlands, Virginia. As of, and for the twelve
months ended December 31, 1995, the Company reported net interest income, loans
and deposits of $10.6 million, $200.1 million and $261.8 million, respectively.
As a result of its growth strategy, at December 31, 2001, the Company reported
net interest income of $21.7 million, loans of $535.3 million and deposits of
$586.8 million.
FNB Southeast is community oriented and focuses primarily on offering
commercial, real estate and consumer loans, and deposit and other financial
services to individuals, small to medium-sized businesses and other
organizations in its market areas. The Company emphasizes its individualized
services and community involvement, while at the same time providing its
customers with the financial sophistication and array of products typically
offered by larger banks. The Company competes successfully with larger banks
located within and outside North Carolina and Virginia by retaining its
personalized approach and community focus.
Under the leadership of Ernest J. Sewell, who became President and
Chief Executive Officer in January 1995, the Company adopted the following
three-part strategy: (1) increase market share and geographic reach through
opportunistic acquisitions in markets where the mix of economic, operational,
cultural and other factors are favorable; (2) position the Company to manage its
planned growth by adding experienced personnel and upgrading its internal
systems and procedures; and (3) generate internal growth at its existing banking
offices by offering new and complementary services and products. To accomplish
these objectives, during the past seven years the Company has: (a) increased the
number of its North Carolina banking offices to thirteen by opening new offices
in Eden, Ruffin, Madison, Greensboro (three offices), Burgaw and Wilmington (two
offices); (b) expanded the number of its full-time personnel by adding new
employees, including several new vice presidents and senior vice presidents; (c)
completed the merger with Black Diamond to extend the Company's reach into
Virginia in the Norton and Harrisonburg markets; (d) completed a systematic
review and revision of its loan administration, loan
1
policy and credit procedures; and (e) enhanced its mix of products and services
by forming an investment services subsidiary, broadening the scope of its
commercial lending activities, and by updating and extending its ATM terminals
and network.
The Company plans to continue to pursue these objectives by
strengthening its presence in existing markets and opportunistically reaching
into new markets in North Carolina, Virginia and South Carolina. The Company
intends to hire qualified personnel to help manage its planned growth and to
develop new products that are uniquely consistent with the Company's customer
service orientation. The Company also plans, where appropriate, to upgrade its
systems and procedures and refine its ability to offer customers sophisticated
services without sacrificing its personalized approach.
Strategy
Expand Banking Operations. Throughout most of its 92-year history,
the Company's banking activities were centered in Reidsville, North Carolina,
located in Rockingham County in the north central part of the State. Beginning
in 1995, however, the Company initiated a growth strategy to further penetrate
markets in which it had an existing market share and expand into and develop new
and contiguous markets, such as Wilmington and Greensboro in North Carolina and
into Virginia. Management selects its target markets based on a number of
factors, including market size and growth potential, banking relationships
developed by members of management during their careers and the ability to
integrate the targeted market into the Company's community oriented culture.
The Company's expansion strategy, both within and outside of its
existing markets, involves three key elements: (i) ascertain which markets may
be underserved by financial institutions whose primary focus is to cater to the
individualized needs of the customer; (ii) install high-quality, well-trained
management to serve the market; and (iii) find reasonably priced facilities.
Management believes that it has been successful in implementing these strategic
elements in its expansion program to date.
In August 1999, the Company merged with Black Diamond and acquired
offices in Norton, Harrisonburg, Pennington Gap and Richlands, Virginia. These
branches serve the market areas of Wise, Tazewell, Russell, Lee, Rockingham and
Augusta Counties in Virginia. In December 1999, the Company opened a full
service banking office in Burgaw, North Carolina. This office serves the Pender
County market plus the surrounding area and compliments the Company's presence
in adjacent New Hanover County. In April 2000, a second office was opened in
Wilmington, North Carolina. This office services the residential construction
market. The Company also opened two additional branches in Greensboro, North
Carolina, during April 2000. These two facilities supplement the existing
office, and the Company now has three full service offices in this dynamic
market. In August 2001, the Company consolidated its two offices in
Harrisonburg, Virginia to more efficiently service this market.
Seize Market Expansion Opportunities. The Company intends to continue
to capitalize on opportunities to enter new and contiguous markets which it
believes are underserved as a result of banking consolidation and in which the
Company's community oriented philosophy and culture might flourish. The Company
believes that there is value to be added by providing the opportunity for
greater personalized banking relationships that exist with larger commercial
banks in its markets, although the Company also recognizes the need to carefully
analyze markets that are already well served by numerous institutions. The
Company will continue to distinguish itself by emphasizing high quality,
sophisticated services in a hometown environment.
Establish a Platform for Future Growth. The Company seeks to position
itself to manage its expected growth in two fundamental ways: (1) attract,
retain and reward experienced personnel who are committed both to conducting
business in a friendly and personable manner and to serving the communities in
which they work and live; and (2) finalize a program to upgrade, modify and
expand its internal systems, procedures, equipment and software designed to
improve marketing and operating efficiencies. The Company will continue to
analyze technological developments in the banking industry
2
for opportunities to improve or augment its services and products; however,
management will continue to make every effort to maintain the Company's
personalized approach as pressures to succumb to technological advances mount.
The Company believes that FNB Southeast's change from a nationally-chartered
bank to a state-chartered bank in March 1999 and its acquisition of Black
Diamond are ways in which the Company solidified its foundation for future
growth.
Maintain a Friendly Environment for Employees and Customers. The
Company has instituted various programs to instill high morale among its
employees, which the Company believes translates into exceptional customer
service. The Company holds weekly sales meetings to elicit ideas about featured
products and services and to develop and communicate ideas for expanding banking
relationships with existing and potential customers. The Company believes that
the overall effect of these programs is to improve morale, customer service and
financial performance.
Market Areas
For operational purposes, the Company groups its markets into four
regions: the Triad and Wilmington regions of North Carolina, and the Norton and
Harrisonburg regions of Virginia. The Company's deposit market share in
Rockingham County, North Carolina as of June 2001, the most recent date for
which data are available, was 28.7%, which ranked first among banks and thrift
institutions. The following table summarizes the banking offices and deposit
totals for the Company's offices, categorized by city.
Region and City Deposits at December 31,
- --------------- ----------------------------------------
2001 2000 1999
-------- -------- --------
(In thousands)
Triad Region:
Reidsville (1) ................. $198,885 $219,474 $177,480
Eden (2) ....................... 55,417 59,406
50,873
Madison ........................ 22,302 23,387 22,891
Ruffin ......................... 11,152 10,793 9,244
Greensboro (3) ................. 72,749 57,109 39,614
-------- -------- --------
Subtotal ............. 355,961 366,180 308,635
-------- -------- --------
Wilmington Region:
Wilmington (4) ................. 52,489 47,051 42,332
Burgaw ......................... 26,496 21,125 6,995
-------- -------- --------
Subtotal ............. 78,985 68,176 49,327
-------- -------- --------
Norton Region:
Norton ......................... 67,545 57,936 55,436
Pennington Gap ................. 26,103 26,772 25,913
Richlands ...................... 26,203 26,258 23,018
-------- -------- --------
Subtotal ............. 119,851 110,966 104,367
-------- -------- --------
Harrisonburg Region:
Harrisonburg (5) ............... 31,963 24,129 21,913
-------- -------- --------
Total deposits ....... $586,760 $569,451 $484,242
======== ======== ========
(1) Includes three banking offices for all years.
(2) Includes two banking offices for all years.
(3) Includes three banking offices for 2001 and 2000, and one office for 1999.
(4) Includes two banking offices for 2001 and 2000, and one office for 1999.
(5) Includes one banking office for 2001 and two offices for 2000 and 1999.
The following is a summary description of the Company's market areas.
3
Triad Region - Rockingham County. Rockingham County was formed in
1785 and is located in the north central area of North Carolina. It has a land
area of 565 square miles and a population of approximately 90,000. Surrounding
counties are Guilford to the south, Caswell to the east, and Stokes to the west.
The county is bordered on the north by the Commonwealth of Virginia. Piedmont
Triad International Airport is located twenty miles away, and Norfolk Southern
has two rail connection lines in the county. The area is served by U.S. Highways
29, 158 and 220. The county, which consists of several community oriented towns,
provides a full range of municipal services and extends financial support to
certain boards, agencies, and commissions to assist its effort to serve its
citizens. The North Carolina Employment Security Commission reported a December
2001 unemployment rate of 8.1% for Rockingham County. Business and government
leaders in the county have made progress in diversifying the area's economy to
make up for job losses in the textile and tobacco industries.
Triad Region - Greensboro. Greensboro has a diverse economy
attributable to a blend of trade, manufacturing and service businesses. Local
industry is characterized by the production of a wide range of products,
including textiles, apparel, tobacco, machinery, pharmaceuticals, microchips and
electronics equipment. Guilford County, with a population of 420,000, has access
to major domestic and international markets from Interstate Highways 40 and 85;
U.S. Highways 29, 70, 220 and 421; major rail connections; and the Piedmont
Triad International Airport. According to the North Carolina Employment Security
Commission, Guilford County reported an unemployment rate of 5.2% for December
2001, compared to a statewide unemployment rate of 5.9%.
Wilmington Region. Wilmington is the county seat and industrial
center of New Hanover County, located on the southeast coast of North Carolina.
The total population of New Hanover County is approximately 160,000. The county
is served by Interstate Highway 40 and U.S. Highways 17 and 74, as well as major
rail connections. This area is serviced by national and regional airlines
through facilities at the New Hanover International Airport located near
Wilmington. The New Hanover County area has experienced extensive industrial
development and service/trade sector growth over the past twenty years.
Industries in the Wilmington region produce fiber optic cables for the
communications industry, aircraft engine parts, pharmaceuticals, nuclear fuel
components and various textile products. The New Hanover County area economy has
become broadly diversified and has developed into a major resort area, a busy
sea port (one of North Carolina's two deep water ports), a light manufacturing
center, chemical manufacturing center and the distribution hub of southeastern
North Carolina. The North Carolina Employment Security Commission reported a
December 2001 unemployment rate of 6.2% for New Hanover County.
Norton Region. Norton is located in southwestern Virginia in the
midst of the Appalachian Mountains. The mining, retail and service industries of
this region operate from an abundant natural resource base that includes natural
gas, coal, timber and mineral deposits. The area is served by several U.S.
Highways and by major rail connections. FNB Southeast operates branches in
Norton (Wise County), Pennington Gap (Lee County) and Richlands (Tazewell
County). For December 2001, the Virginia Employment Commission reported the
unemployment rate in Wise County was 4.4%.
Harrisonburg Region. Rockingham County is centrally located in the
Shenandoah Valley in west central Virginia. Harrisonburg, the county seat with a
population of 40,000, is an important educational, industrial, retail, tourism,
commercial, agricultural and governmental center. The area is served by
Interstate Highway 81, several primary U. S. highways, the Shenandoah Valley
Regional Airport and a major rail connection. FNB Southeast operates one branch
in Harrisonburg, serving the counties of Rockingham and Augusta. According to
the Virginia Employment Commission, the December 2001 unemployment rate for
Harrisonburg was 2.0% compared to a statewide unemployment rate of 3.6%.
4
Lending Activities
General. The Company offers a broad array of lending services,
including real estate, commercial and consumer loans, to individuals and small
to medium-sized business and other organizations that are located in or conduct
a substantial portion of their business in the Company's market areas. The
Company has also established niche markets such as residential construction
lending in local markets and airplane lending in markets throughout the
southeastern United States. The Company's total loans at December 31, 2001, were
$535.3 million, or 80.0% of total earning assets. The Company also makes secured
construction loans to homebuilders and residential mortgages, which are often
secured by first and second real estate mortgages. At December 31, 2001, the
Company had no large loan concentrations (exceeding ten percent of its
portfolio) in any particular industry.
Loan Composition. The following table summarizes, at the dates
indicated, the composition of the Company's loan portfolio and the related
percentage composition.
(In thousands) As of December 31,
-------------------------------------------------------------------------
2001 2000 1999
--------------------- --------------------- ---------------------
Real Estate:
Commercial ........... $168,419 31.5% $119,584 23.9% $115,434 27.9%
Residential .......... 130,264 24.4 150,825 30.1 130,676 31.6
Construction ......... 55,861 10.4 66,148 13.2 34,680 8.4
-------- ----- -------- ----- -------- -----
Total real estate 354,544 66.3% 336,557 67.2% 280,790 67.9%
Commercial, financial and
agricultural ........ 90,858 17.0% 74,981 15.0% 58,002 14.0%
-------- ----- -------- ----- -------- -----
Consumer:
Direct ............... 37,112 6.9% 46,463 9.3% 32,778 7.9%
Home Equity .......... 46,169 8.6 39,204 7.8 32,836 7.9
Revolving ............ 6,662 1.2 3,432 0.7 9,605 2.3
-------- ----- -------- ----- -------- -----
Total consumer .. 89,943 16.7% 89,099 17.8% 75,219 18.1%
-------- ----- -------- ----- -------- -----
Total loans ............... $535,345 100.0% $500,637 100.0% $414,011 100.0%
======== ===== ======== ===== ======== =====
Real Estate Loans. Loans secured by real estate for a variety of
purposes constituted $354.5 million or 66.3%, of the Company's total loans at
December 31, 2001. The Company held at December 31, 2001, real estate loans of
various sizes ranging up to $4.0 million, secured by office buildings, retail
establishments, warehouses, motels, restaurants and other types of property.
Loan terms are typically limited to five years, with payments through the date
of maturity generally based on a 15-year amortization schedule. Interest rates
may be fixed or adjustable, based on market conditions, and the Company
generally charges an origination fee. Management has attempted to reduce credit
risk in the real estate portfolio by emphasizing loans on owner occupied office
and retail buildings where the loan to value ratio, established by independent
appraisals, does not exceed 80%, and net projected cash flow available for debt
service equals 120% of the debt service requirement. The Company also often
requires personal guarantees of the principal owners of the property and obtains
personal financial statements of the principal owners in such cases. The Company
experienced net charge-offs of $7,000 in 2001, $346,000 in 2000, and no net
charge-offs in 1999.
The Company originates residential loans for its portfolio on single
and multi-family properties, both owner occupied and non-owner occupied, and at
December 31, 2001, it held $130.3 million of such loans. Loan terms are
typically limited to five years, with payments through the date of maturity
generally based on a 15 or 30 year amortization schedule. Rates may be fixed or
variable, and the Company typically charges an origination fee. The Company
attempts to minimize credit risk by requiring a loan to value ratio of 80% or
less. The Company experienced net charge-offs losses of $36,000 in 2001, $13,000
in 2000, and no net charge-offs in 1999.
5
The Company also originates residential loans for sale into the
secondary market. Through its mortgage banking activities, the Company
originates both fixed and variable rate residential mortgage loans for sale with
servicing released. The Company is able to generate loan origination fees,
typically ranging from 1.0% to 1.5% of the loan balance, which are recognized as
income when the loan is sold. During 2001, 2000 and 1999, the Company earned
loan origination fees of $376,000, $264,000, and $249,000, respectively. At
December 31, 2001, the Company held $1.1 million of such loans for sale, and
during 2001 the Company sold an aggregate of $18.4 million of such loans. The
Company sells these loans on a non-recourse basis.
The Company's current lending strategy is for the majority of
construction and development loans on commercial and residential projects to be
in the range of $0.3 million to $4.0 million. At December 31, 2001, 2000 and
1999, the Company held $55.9 million, $66.1 million and $34.7 million,
respectively, of such loans. To reduce credit risk associated with such loans,
the Company limits its lending to projects involving small commercial centers
that have strong anchor tenants and are substantially pre-leased, or residential
projects built in strong, proven markets. The leases on commercial projects must
generally result in a loan to appraised value of 80% and a net cash flow to debt
service at no less than 120%. The Company historically has required a personal
guarantee from the developer or builder. Loan terms are typically twelve to
fifteen months on a commercial project and twelve to fifteen months on a
residential project, although the Company occasionally will make a
"mini-permanent" loan for purposes of construction and development up to a three
to five year term. Rates are typically variable, and the Company typically
charges an origination fee. The Company experienced no net charge-offs during
2001, 2000 or 1999.
Commercial Loans. The Company makes loans for commercial purposes to
various types of businesses. At December 31, 2001, the Company held $90.9
million of commercial loans, or 17.0% of its total loan portfolio. Equipment
loans are typically made on terms up to five years at fixed or variable rates,
with the financed equipment pledged as collateral to the Company. The Company
attempts to reduce its credit risk on these loans by limiting the loan to value
ratio to 80%. Working capital loans are made on terms typically not exceeding
one year. These loans may be secured or unsecured, but the Company attempts to
limit its credit risk by requiring the borrower to demonstrate its capacity to
produce net cash flow available for debt service equal to 110% to 150% of its
debt service requirements. The Company experienced net charge-offs of $485,000
in 2001, $62,000 in 2000, and net recoveries of $5,000 in 1999.
Consumer Loans. The Company makes a variety of loans to individuals
for personal and household purposes, including (i) secured and unsecured
installment and term loans originated directly by the Company; (ii) home equity
revolving lines of credit; and (iii) unsecured revolving lines of credit. The
home equity loans and certain of the direct loans are secured by the borrower's
residence. At December 31, 2001, the Company held $89.9 million of consumer
loans, including home equity lines of credit. During 2001, 2000, and 1999,
respectively, the Company experienced net consumer charge-offs of $336,000,
$258,000, and $249,000.
Credit Card Loans. In 1996, the Company began offering credit card
loans to individuals and businesses that met the Company's underwriting
standards with respect to income, credit rating, established residence and
employment. In February 2000, the Company sold its entire credit card portfolio
of $3.4 million to a third party. The Company received approximately a 3%
premium on this sale. The loans were sold without recourse. The Company
experienced recoveries of $6,000 in 2001 and recoveries of $29,000 in 2000, and
net charge-offs of $173,000 in 1999.
Loan Approval and Review. The Company has adopted various levels of
officer lending authority in connection with its loan approval policies. When
the aggregate outstanding loans to a single borrower exceed that individual
officer's lending authority, the loan request must be considered and approved by
an officer with a higher lending limit. Branch loan officers and community
executives typically have retail
6
lending limits ranging from $75,000 to $250,000. Community executives can
approve commercial loans up to $500,000. If the lending request exceeds the
community executive's lending limit, the loan must be submitted to and approved
by the appropriate senior credit officer. The senior credit officer and selected
regional executives have authority to approve a commercial loan up to $750,000.
Under joint approval, the senior credit officer and selected regional executives
may approve loans up to $1.5 million. All loans in excess of $1.5 million must
be approved by the President and Chief Executive Officer, who may approve loans
up to $2.5 million.
The Company has a continuous loan review procedure involving multiple
officers of the Company which is designed to promote early identification of
credit quality problems through its credit management committee. All loan
officers are charged with the responsibility of reviewing on an annual basis all
credit relationships in excess of $100,000 in their respective portfolios. Loan
officers also review all criticized and classified assets in their portfolio
quarterly with the senior loan officers of the Company. The loan officers are
responsible for implementing, where appropriate, approved action plans with
respect to such criticized and classified assets designed to improve the
Company's credit position for an early resolution of the problem loan. As part
of its overall strategy to improve policies and procedures, the Company also
engaged a third party consultant to review its loan portfolio. The first
examination occurred in 1998. The Company has used the findings of the
examinations to further enhance credit quality through improved credit
administration policies and procedures.
The Company's credit review system supplements the Company's loan
rating system, pursuant to which the Company may place a loan on its criticized
asset list or may classify a loan in one of various other classification
categories. A specified minimum percentage of loans in each adverse asset
classification category, based on the historical loss experience in the Company
in each such category, is used to determine the adequacy of the Company's
allowance for credit losses quarterly. These loans are also individually
reviewed by senior credit officers of the Company to determine whether a greater
allowance allocation is justified due to the facts and circumstances of a
particular adversely classified loan.
See also Note 5 in the Notes to Consolidated Financial Statements on
page 50 of this Annual Report on Form 10-K.
Outsourcing of Certain Operational Functions. The Company has
agreements with third parties to provide a variety of specialized functions to
the Company in connection with its lending operations. In each of the
relationships, the Company benefits from the service provider's expertise and
economies of scale while retaining the flexibility to take advantage of changes
in available technology without adversely affecting customer service.
Investments
The Company seeks to maintain an investment portfolio consistent with
the overall financial needs of the Company. The following items may be
considered in the purchase or sale of investment securities: liquidity,
maturity, credit quality, income or other factors. The portfolio consists of
United States treasury obligations, federal agency and municipal securities,
mortgage-backed securities and other investment securities.
See also Note 4 in the Notes to Consolidated Financial Statements on
page 49 of this Annual Report on Form 10-K.
7
Deposits
The Company offers a variety of deposit programs to individuals and
to small and medium-sized businesses and other organizations at interest rates
generally competitive with local market conditions. The following table sets
forth the mix of depository accounts at the Company as a percentage of total
deposits at the dates indicated.
As of December 31,
------------------------------------------------------------
2001 2000 1999
----- ----- -----
Non-interest bearing demand............... 10.0% 9.6% 9.9%
Savings, NOW, MMI........................ 15.9 14.5 19.2
Certificates of deposit....................... 74.1 75.9 70.9
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
The Company accepts deposits at its 17 banking offices, ten of which
have automated teller machines ("ATMs"). In addition, the Company operates a
network of 38 remote ATMs in Norton, Virginia, and the surrounding area; three
remote ATMs in Reidsville, North Carolina; and two remote ATMs in Wilmington,
North Carolina. The Company's memberships in the "STAR", "CIRRUS" and "PLUS"
networks allow customers access to their depository accounts from regional ATM
facilities. The Company charges fees ranging from $1.50 to $1.75 per transaction
for the use of its ATM facilities by those who are not depositors with the
Company. The Company controls deposit flows primarily through the pricing of
such deposits and, to a certain extent, through promotional activities. Such
promotional activities include the Company's "Prestige" and "Priority" accounts
for deposits of $25,000 and $75,000, respectively, and the "FNB Club", which
extends special privileges and sponsors group excursions to sites and
performances of interest to account holders over the age of 55. At December 31,
2001, the Company had $224.5 million in certificates of deposit of $100,000 or
more. In January 1998, the Company joined an electronic network which allows it
to post interest rates and attract certificates of deposit nationally. The
investors are generally credit unions or commercial banks and amounts are
typically just under $100,000 to assure FDIC insurance coverage. The Company
also utilizes brokered deposits to supplement deposit growth. Management
believes these deposits provide effective funding sources and serve to broaden
the Company's funding base. The table below presents the scheduled maturities of
time deposits of $100,000 or more at December 31, 2001.
Scheduled maturity of time deposits of $100,000 or more Amount
------------------------------------------------------- --------
(In thousands)
Less than three months................................... $ 76,114
Three through six months................................. 98,563
Seven through twelve months.............................. 35,366
Over twelve months....................................... 14,489
---------
Total time deposits................................. $ 224,532
=========
See also Note 8 in the Notes to Consolidated Financial Statements on
page 51 of this Annual Report on Form 10-K.
Investment Services
In April 2000, the Company established FNB Southeast Investment
Services, Inc. as a wholly-owned subsidiary of FNB Southeast. FNB Southeast
Investment Services, Inc. employs an investment advisor who splits his time
among the Company's branches and is available to current customers and potential
customers of the Company. This advisor offers a complete line of investment
products and services. The Company receives a commission based on the advisor's
sales. The Company benefits by
8
earning additional fee income and by attracting additional people to its
branches who may become customers of the Bank. In 2001, the Company generated
$203,000 in revenues through the third party service provider and the
subsidiary.
Mortgage Banking
In June 2001, the Company established FNB Southeast Mortgage
Corporation as a wholly-owned subsidiary of FNB Southeast. The new subsidiary
purchased the assets of Airlie Mortgage Company, Inc., a successful mortgage
brokerage company operating three offices in the coastal area near Wilmington,
North Carolina
Marketing
The Company currently markets its services through advertising
campaigns and in printed material, such as newspapers, magazines and direct
mailings, as well as through promotional items, such as caps, pens, pencils and
shirts. The Company's officers are also heavily involved in local civic affairs
and philanthropic organizations in order to focus customers on products and
services at a personal level. The Company occasionally sponsors community events
and holds grand opening ceremonies for its new branches to which local
dignitaries are invited to speak and participate in the festivities. Since the
Company does not have a fully-staffed marketing department, the Company's
marketing, advertising and public relations campaigns focus on the following two
components:
o Value. Among other things, the Company offers attractive
rates for its financial products, including its certificates
of deposit and checking accounts. This pricing structure has
been successful in attracting depositors who are motivated
by the Company's rates, as well as by the variety of
individualized services the Company promotes and offers.
o Convenience and Service. All personnel of the Company aim
toward serving the individual needs of the Company's
customers. For example, senior personnel are accessible on
very short notice, even after normal banking hours, by way
of pagers and other means. In addition, all employees are
eligible to earn incentive compensation for sales and cross
sales to customers.
Management intends to continue to market the Company's services
through a combination of advertising campaigns, public relations activities and
local affiliations. In most of its markets, the Company has established advisory
boards, comprised of local community leaders, to promote the Company. While the
key messages of value, convenience, service and reliability will continue to
play a major role in the Company's marketing and public relations efforts,
management may also focus on targeted groups, such as professionals, in addition
to small to medium-sized local businesses.
A vital part of the Company's marketing plan is the execution of a
public relations strategy. Many traditional public relations methods will be
used in promoting its services. Management intends to pursue media coverage,
including general press, industry periodicals and other media covering banking
and finance, consumer issues and special interests. Press releases, quarterly
shareholder reports, media alerts and presentations will announce new banking
services as they are added. In addition, a professional marketing firm has been
engaged by the Company to assist in promoting the overall image of the Company
to the general public and investment community.
Competition
Commercial banking in the southeastern portion of the United States
is extremely competitive, due in large part to interstate branching. Currently,
many of the Company's competitors are significantly larger and have greater
resources than the Company. The Company continues to encounter significant
9
competition from a number of sources, including bank holding companies,
financial holding companies, commercial banks, thrift institutions, credit
unions, and other financial institutions and financial intermediaries. The
Company competes in its market areas with some of the largest banking
organizations in the Southeast, several of which have as many as 200 or 300
branches in North Carolina and Virginia. The Company's competition is not
limited to financial institutions based in North Carolina and Virginia. The
enactment of federal legislation authorizing nationwide interstate banking has
greatly increased the size and financial resources of some of the Company's
competitors. Consequently, many of the Company's competitors have substantially
higher lending limits due to their greater total capitalization, and many
perform functions for their customers, such as trust services, that the Company
does not offer. The Company primarily relies on providing quality products and
services at a competitive price within the market area. As a result of recent
interstate banking legislation, the Company's market is open to future
penetration by banks located in other states provided that the other states
allow their domestic banking institutions to acquire North Carolina banking
institutions, thereby increasing competition.
In the Triad region of North Carolina as of June 2001, the Company
competed with 17 commercial banks and two savings institutions, as well as
numerous credit unions. For the same period, the Company competed with nine
commercial banks, one savings institution and several credit unions in the
Wilmington region of North Carolina. In the Norton region of Virginia as of June
2001, the Company competed with 18 commercial banks. For the same period, the
Company competed with 17 commercial banks in the Harrisonburg region of
Virginia.
Employees
On December 31, 2001, the Company had approximately 204 full-time and
8 part-time employees. None of the Company's employees are represented by a
collective bargaining unit. The Company considers its relations with its
employees to be good.
10
Supervision and Regulation
Financial holding companies and commercial banks are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes and rules and regulations that affect or will affect the
Company and FNB Southeast. This summary is qualified in its entirety by
reference to the particular statute and regulatory provisions referred to below
and is not intended to be an exhaustive description of the statutes or
regulations applicable to the business of the Company and FNB Southeast.
Supervision, regulation and examination of the Company and FNB Southeast by the
regulatory agencies are intended primarily for the protection of depositors
rather than shareholders of the Company.
Regulation of the Company
General. The Company is a financial holding company, registered with
the Board of Governors of the Federal Reserve (the "Federal Reserve") under the
Bank Holding Company Act of 1956, (the "BHCA") as amended by the
Gramm-Leach-Bliley Act (the "GLB Act" or the "Act"), which was enacted on
November 12, 1999 (and further discussed herein). As a result of the Company's
ownership of the Bank, the Company is also registered with the North Carolina
Commissioner of Banks (the "Commissioner") under the North Carolina Bank Holding
Company Act of 1984, as amended. In addition to being subject to the
supervision, examination and regulation of the Federal Reserve and the
Commissioner, the Company is also subject to the backup supervisory power of the
Federal Deposit Insurance Corporation (the "FDIC") as a result of the Bank's
deposits being insured by the FDIC to the extent provided by law.
The Company qualified as a financial holding company under the BHCA,
as amended by the GLB Act, in February 2001. Prior to that time, it was a bank
holding company, subject to the BHCA and Federal Reserve regulations. Under the
BHCA, as amended, a bank holding company which does not qualify as a financial
holding company is prohibited from engaging in activities other than (i)
banking, managing or controlling banks or other permissible subsidiaries, (ii)
furnishing services to or performing services for its subsidiaries or (iii)
engaging in any other activity which the Federal Reserve determines to be so
closely related to banking or managing or controlling banks as to be proper
incident thereto. In addition, the BHCA prohibits bank holding companies from
engaging in, or acquiring the ownership or control of, more than 5% of the
outstanding voting stock of any company engaged, in a non-banking business
unless such business was determined by the Federal Reserve to be so closely
related to banking as to be properly incident thereto.
However, under the amendments to the BHCA, as codified in the GLB
Act, certain barriers separating banking, securities and insurance firms were
removed. Title I of the Act allows financial organizations to structure new
financial affiliations through a holding company structure, or a financial
subsidiary (with limitations on activities and appropriate safeguards). Bank
holding companies, such as the Company, are now permitted to qualify as
financial holding companies and expand into a wide variety of services that are
financial in nature, provided that their subsidiary depository institutions are
well-managed, well-capitalized and have received a "satisfactory" rating on
their last Community Reinvestment Act ("CRA") examination. A bank holding
company which does not qualify as a financial holding company under the Act is
generally limited in the types of activities in which it may engage to those
that the Federal Reserve Board had recognized as permissible for a bank holding
company prior to the effective date of the Act. The Company is now permitted to
take advantage of these additional types of activities if it so chooses in the
future as a result of its election to become a financial holding company.
The Act designates the Federal Reserve as the overall umbrella
supervisor of the new financial services holding companies. The Act adopts a
system of functional regulation where the primary regulator is determined by the
nature of activity rather than the type of institution. Under this principle,
securities activities are regulated by the SEC and other securities regulators,
insurance activities by the state insurance authorities, and banking activities
by the appropriate banking regulator. As a result, to the
11
extent the Company or a financial subsidiary of the Company engages in
non-banking activities permitted under the Act, it will be subject to the
regulatory authority of the SEC or state insurance authority, as applicable.
The Company remains subject to a number of restrictions imposed on
all bank holding companies. The BHCA prohibits the Company from acquiring direct
or indirect control of more than 5% of the outstanding voting stock or
substantially all of the assets of any bank or savings bank or merging or
consolidating with another bank holding company or savings bank holding company
without prior approval of the Federal Reserve.
Similarly, Federal Reserve approval (or, in certain cases,
non-objection) must be obtained prior to any person acquiring control of the
Company. Control is conclusively presumed to exist if, among other things, a
person owns, controls, or has the power to vote 25% or more of any class of
voting stock of the holding company or controls in any manner the election of a
majority of the directors of the holding company. Control is presumed to exist
if a person owns, controls, or has the power to vote more than 10% of any class
of voting stock and the stock is registered under Section 12 of the Exchange Act
or the acquirer will be the largest shareholder after the acquisition.
A number of legal and regulatory obligations and restrictions are
imposed on bank holding companies, as well as their depository institution
subsidiaries, which are designed to minimize potential losses to depositors of
such depository institutions and the FDIC insurance funds. For example, in order
to avoid receivership of an insured depository institution subsidiary, a bank
holding company is required to guarantee the compliance of any insured
depository institution subsidiary that has become "undercapitalized" with the
terms of any capital restoration plan filed by such subsidiary with its
appropriate federal banking agency up to the lesser of (i) an amount equal to 5%
of the institution's total assets at the time the institution became
undercapitalized, or (ii) the amount which is necessary to bring the institution
into compliance with all acceptable capital standards as of the time the
institution initially fails to comply with such capital restoration plan. Under
a policy of the Federal Reserve with respect to bank holding company operations,
a bank holding company is required to serve as a source of financial strength to
its subsidiary depository institutions and to commit resources to support such
institutions in circumstances where it might not do so absent such policy. The
Federal Reserve under the BHCA also has the authority to require a bank holding
company to terminate any activity or to relinquish control of a nonbank
subsidiary (other than a nonbank subsidiary of a bank) upon the Federal
Reserve's determination that such activity or control constitutes a serious risk
to the financial soundness and stability of any bank subsidiary of the bank
holding company.
In addition, the "cross-guarantee" provisions of the Federal Deposit
Insurance Act, as amended, require insured depository institutions under common
control to reimburse the FDIC for any loss suffered by either the Savings
Association Insurance Fund (the "SAIF") or the Bank Insurance Fund (the "BIF")
as a result of the default of a commonly controlled insured depository
institution or for any assistance provided by the FDIC to a commonly controlled
insured depository institution in danger of default. The FDIC may decline to
enforce the cross-guarantee provisions if it determines that a waiver is in the
best interest of the SAIF or the BIF or both. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or any
affiliate but is subordinate to claims of depositors, secured creditors and
holders of subordinated debt (other than affiliates) of the commonly controlled
insured depository institutions.
Federal regulations require that the Company must notify the Federal
Reserve Bank of Richmond prior to repurchasing Common Stock in excess of ten
percent of its net worth during a rolling twelve month period unless the Company
(i) both before and after the redemption satisfies capital requirements for
"well capitalized" state member banks, (ii) received a one or two rating in its
last examination, and (iii) is not the subject of any unresolved supervisory
issues.
12
Additional Provisions Under the GLB Act. In addition to removing
certain barriers which had separated banking, securities and insurance firms (as
previously discussed), the GLB Act made other reforms.
The GLB Act imposes restrictions on the ability of financial services
firms, such as the Company and the Bank, to share customer information with
non-affiliated third parties. The Act: (i) requires financial services firms to
establish privacy policies and disclose them annually to customers, explaining
how nonpublic personal information is shared with affiliates and third parties;
(ii) currently requires that regulatory agencies have standards for sharing
customer information; (iii) permits customers to prohibit ("opt-out") of the
disclosure of personal information to non-affiliated third parties; (iv)
prohibits the sharing of customer information with marketers of credit card and
other account numbers; and, (v) prohibits "pretext" calling. The privacy
provisions, however, do allow a community bank to share information with third
parties that sell financial products, such as insurance companies or securities
firms. The privacy provision became effective in November 2000, with full
compliance required by July 1, 2001.
In addition to the foregoing, the GLB Act (1) reforms the Federal
Home Loan Bank System to provide small banks with greater access to funds for
making loans to small business and small farmers, (2) obligates operators of
automated teller machines ("ATMs") to provide notices to customers regarding
surcharge practices, and (3) provides that financial institutions with less than
$250 million in assets will normally be examined for compliance with the
Community Reinvestment Act ("CRA") only once every five years if they maintain
an "outstanding" rating and once every four years they if have a "satisfactory"
rating. CRA agreements between financial institutions and community groups must
be disclosed and reported to the public.
Capital Adequacy Guidelines for Holding Companies. The Federal
Reserve has adopted capital adequacy guidelines for bank holding companies and
banks that are members of the Federal Reserve system and have consolidated
assets of $150 million or more. For bank holding companies with less than $150
million in consolidated assets, the guidelines are applied on a bank-only basis
unless the parent bank holding company (i) is engaged in nonbank activity
involving significant leverage or (ii) has a significant amount of outstanding
debt that is held by the general public.
Bank holding companies subject to the Federal Reserve's capital
adequacy guidelines are required to comply with the Federal Reserve's risk-based
capital guidelines. Under these regulations, the minimum ratio of total capital
to risk-weighted assets (including certain off-balance sheet activities, such as
standby letters of credit) is 8%. At least half of the total capital is required
to be "Tier I Capital," principally consisting of common stockholders' equity,
non-cumulative perpetual preferred stock, and a limited amount of cumulative
perpetual preferred stock, less certain goodwill items. The remainder ("Tier II
Capital") may consist of a limited amount of subordinated debt, certain hybrid
capital instruments and other debt securities, perpetual preferred stock, and a
limited amount of the general loan loss allowance. In addition to the risk-based
capital guidelines, the Federal Reserve has adopted a minimum Tier I Capital
(leverage) ratio, under which a bank holding company must maintain a minimum
level of Tier I Capital to average total consolidated assets of at least 3% in
the case of a bank holding company which has the highest regulatory examination
rating and is not contemplating significant growth or expansion. All other bank
holding companies are expected to maintain a Tier I Capital (leverage) ratio of
at least 1% to 2% above the stated minimum.
Dividend and Repurchase Limitations. Federal regulations require that
the Company must obtain Federal Reserve approval in order to use more than 10%
of its net worth to make stock repurchases during any 12 month period unless the
Company (i) both before and after the redemption satisfies capital requirements
for "well capitalized" state member banks; (ii) received a one or two rating in
its last examination; and (iii) is not the subject of any unresolved supervisory
issues.
13
Although the payment of dividends and repurchases of stock by the
Company are subject to certain requirements and limitations of North Carolina
corporate law, except as set forth in this paragraph, neither the Commissioner
nor the FDIC have promulgated any regulations specifically limiting the right of
the Company to pay dividends and repurchase shares. However, the ability of the
Company to pay dividends or repurchase shares may be dependent upon the
Company's receipt of dividends from the Bank. The Bank's ability to pay
dividends is limited. See "Regulation of the Bank - Dividends."
Federal Securities Laws. The Company has registered its Common Stock
with the SEC pursuant to Section 12(g) of the Exchange Act and will not
deregister the Common Stock for a period of three years following the completion
of the Conversion. As a result of such registration, the proxy and tender offer
rules, insider trading reporting requirements, annual and periodic reporting and
other requirements of the Exchange Act are applicable to the Company.
Regulation of the Bank
General. Prior to March 15, 1999, FNB Southeast was a national bank
regulated by the Office of Comptroller of the Currency ("OCC"). Effective March
15, 1999, FNB Southeast converted its charter from a national bank to a North
Carolina state bank and became a member of the Federal Reserve.
Dividends. North Carolina commercial banks, such as FNB Southeast,
are subject to legal limitations on the amounts of dividends they are permitted
to pay. Dividends may be paid by the Bank from undivided profits, which are
determined by deducting and charging certain items against actual profits,
including any contributions to surplus required by North Carolina law. In
addition, without the prior approval of the Federal Reserve Board, FNB Southeast
may not declare or pay a dividend if the total of all dividends declared during
the calendar year, including the proposed dividend, exceeds the sum of the
Bank's net income during that current calendar year and the retained net income
of the prior two calendar years. The Federal Reserve regulations also prohibit
the payment of dividends without the prior approval of the Federal Reserve Board
and two thirds of the shareholders when the dividend (i) would exceed the Bank's
undivided profits or (ii) any portion of the dividend would be from the Bank's
permanent capital. Also, an insured depository institution, such as FNB
Southeast, is prohibited from making capital distributions, including payment of
dividends, if, after making such distribution, the institution would become
"undercapitalized" (as such term is defined in the applicable law and
regulations). Based on its current financial condition, FNB Southeast does not
expect that this provision will have any impact on the Bank's ability to pay
dividends.
Capital Requirements. The Bank, as a North Carolina commercial bank,
is required to maintain a surplus account equal to 50% or more of its paid-in
capital stock. As a member bank of the Federal Reserve, the Bank is also subject
to the capital requirements imposed by the Federal Reserve. Under Federal
Reserve regulations, member banks must maintain a minimum ratio of qualifying
capital to weighted risk assets equal to 8%. At least half of the total capital
is required to be Tier I Capital, with the remainder consisting of Tier II
Capital. In addition to the foregoing risk based capital guidelines, member
banks which receive the highest rating in the examination process and are not
anticipating or experiencing any significant growth, must maintain a minimum
level of Tier I Capital to total assets of 3%. Member banks which do not fall
within the foregoing standards are required to maintain higher capital ratios.
Deposit Insurance Assessments. The Bank is also subject to insurance
assessments imposed by the FDIC. Under current law, the insurance assessment to
be paid by the BIF members such as the Bank shall be as specified in a schedule
required to be issued by the FDIC. All FDIC deposits for deposit insurance have
an effective rate ranging from 0 to 31 basis points per $100 of insured
deposits, depending on the institution's capital position and other supervisory
factors. Based on the current financial condition and capital levels of the
Bank, the Bank does not expect that the FDIC insurance assessments will have a
material impact on the Bank's future earnings.
14
Transactions with Affiliates. Under current federal law, depository
institutions are subject to the restrictions contained in Section 22(h) of the
Federal Reserve Act with respect to loans to directors, executive officers and
principal shareholders. Under Section 22(h), loans to directors, executive
officers and shareholders who own more than 10% of a depository institution (18%
in the case of institutions located in an area with less than 30,000 in
population), and certain affiliated entities of any of the foregoing, may not
exceed, together with all other outstanding loans to such person and affiliated
entities, the institution's loans-to-one-borrower limit (as discussed below).
Section 22(h) also prohibits loans above amounts prescribed by the appropriate
federal banking agency to directors, executive officers and shareholders who own
more than 10% of an institution, and their respective affiliates, unless such
loans are approved in advance by a majority of the board of directors of the
institution. Any "interested" director may not participate in the voting. The
FDIC has prescribed the loan amount (which includes all other outstanding loans
to such person), as to which such prior board of director approval is required,
as being the greater of $25,000 or 5% of capital and surplus (up to $500,000).
Further, pursuant to Section 22(h), the Federal Reserve requires that loans to
directors, executive officers, and principal shareholders be made on terms
substantially the same as offered in comparable transactions with non-executive
employees of the Bank. The FDIC has imposed additional limits on the amount a
bank can loan to an executive officer.
Loans to One Borrower. The Bank is subject to the Commissioner's
loans to one borrower limits which are substantially the same as those
applicable to national banks. Under these limits, no loans and extensions of
credit to any borrower outstanding at one time and not fully secured by readily
marketable collateral shall exceed 15% of the unimpaired capital and unimpaired
surplus of the bank. Loans and extensions of credit fully secured by readily
marketable collateral may comprise an additional 10% of unimpaired capital and
unimpaired surplus.
Limits on Rates Paid on Deposits and Brokered Deposits. Regulations
promulgated by the FDIC place limitations on the ability of insured depository
institutions to accept, renew or roll-over deposits by offering rates of
interest which are significantly higher than the prevailing rates of interest on
deposits offered by other insured depository institutions having the same type
of charter in such depository institution's normal market area. Under these
regulations, "well capitalized" depository institutions may accept, renew or
roll-over such deposits without restriction, "adequately capitalized" depository
institutions may accept, renew or roll-over such deposits with a waiver from the
FDIC (subject to certain restrictions on payments of rates) and
"undercapitalized" depository institutions may not accept, renew, or roll-over
such deposits. The regulations contemplate that the definitions of "well
capitalized," "adequately capitalized" and "undercapitalized" will be the same
as the definitions adopted by the FDIC to implement the corrective action
provisions discussed below.
Only a "well capitalized" (as defined in the statute as significantly
exceeding each relevant minimum capital level) depository institution may accept
brokered deposits without prior regulatory approval. "Adequately capitalized"
banks may accept brokered deposits with a waiver from the FDIC (subject to
certain restrictions on payment of rates), while "undercapitalized" banks may
not accept brokered deposits. The regulations contemplate that the definitions
of "well capitalized," "adequately capitalized" and "undercapitalized" are the
same as the definitions adopted by the agencies to implement the prompt
corrective action provisions discussed below.
Federal Home Loan Bank System. The FHLB system provides a central
credit facility for member institutions. As a member of the FHLB of Atlanta, the
Bank is required to own capital stock in the FHLB of Atlanta in an amount at
least equal to the greater of 1% of the aggregate principal amount of its unpaid
residential mortgage loans, home purchase contracts and similar obligations at
the end of each calendar year, or 5% of its outstanding advances (borrowings)
from the FHLB of Atlanta. On December 31, 2001 the Bank was in compliance with
this requirement.
15
Community Reinvestment. Under the Community Reinvestment Act ("CRA")
as implemented by regulations of the FDIC, an insured institution has a
continuing and affirmative obligation consistent with its safe and sound
operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions, nor does it limit an
institution's discretion to develop, consistent with the CRA, the types of
products and services that it believes are best suited to its particular
community. The CRA requires the federal banking regulators, in connection with
their examinations of insured institutions, to assess the institutions' records
of meeting the credit needs of their communities, using the ratings of
"outstanding," "satisfactory," "needs to improve," or "substantial
noncompliance," and to take that record into account in its evaluation of
certain applications by those institutions. All institutions are required to
make public disclosure of their CRA performance ratings. The Bank received a
"satisfactory" rating in its last CRA examination which was conducted during
June 2000.
Prompt Corrective Action. The Federal Reserve has broad powers to
take corrective action to resolve the problems of insured depository
institutions. The extent of these powers will depend upon whether the
institutions in question are "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," or "critically
undercapitalized." Under the regulations, an institution is considered "well
capitalized" if it has (i) a total risk-based capital ratio of 10% or greater,
(ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio
of 5% or greater and (iv) is not subject to any order or written directive to
meet and maintain a specific capital level for any capital measure. An
"adequately capitalized" institution is defined as one that has (i) a total
risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital
ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or
greater in the case of an institution with the highest examination rating). An
institution is considered (A) "undercapitalized" if it has (i) a total
risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio
of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of
an institution with the highest examination rating); (B) "significantly
undercapitalized" if the institution has (i) a total risk-based capital ratio of
less than 6%, or (ii) a Tier I risk-based capital ratio of less than 3% or (iii)
a leverage ratio of less than 3% and (C) "critically undercapitalized" if the
institution has a ratio of tangible equity to total assets equal to or less than
2%. At December 31, 2001, FNB Southeast had the requisite capital levels to
qualify as "well capitalized."
Other. The federal banking agencies, including the Federal Reserve,
have developed joint regulations requiring disclosure of contingent assets and
liabilities and, to the extent feasible and practicable, supplemental disclosure
of the estimated fair market value of assets and liabilities. Additional joint
regulations require annual examinations of all insured depository institutions
by the appropriate federal banking agency, with some exceptions for small,
well-capitalized institutions and state chartered institutions examined by state
regulators, and establish operational and managerial, asset quality, earnings
and stock valuation standards for insured depository institutions, as well as
compensation standards where such compensation would endanger the insured
depository institution or would constitute an unsafe practice.
The Bank is subject to examination by the Federal Reserve and the
Commissioner. In addition, the Bank is subject to various other state and
federal laws and regulations, including state usury laws, laws relating to
fiduciaries, consumer credit and equal credit, fair credit reporting laws and
laws relating to branch banking. The Bank, as an insured North Carolina
commercial bank, is prohibited from engaging as a principal in activities that
are not permitted for national banks, unless (i) the FDIC determines that the
activity would pose no significant risk to the appropriate deposit insurance
fund and (ii) the Bank is, and continues to be, in compliance with all
applicable capital standards.
Under Chapter 53 of the North Carolina General Statutes, if the
capital stock of a North Carolina commercial bank is impaired by losses or
otherwise, the Commissioner is authorized to require payment of the deficiency
by assessment upon the bank's shareholders, pro rata, and to the extent
necessary, if any such assessment is not paid by any shareholder, upon 30 days
notice, to sell as much as is necessary of the stock of such shareholder to make
good the deficiency.
16
The Bank does not believe that these regulations have had or will
have a material adverse effect on its current operations.
Taxation. Federal Income Taxation. Financial institutions such as the
Bank are subject to the provisions of the Internal Revenue Code of 1986, as
amended (the "Code") in the same general manner as other corporations. However,
banks which meet certain definitional tests and other conditions prescribed by
the Code may benefit from certain favorable provisions regarding their
deductions from taxable income for annual additions to their bad debt reserve.
The Bank may compute its addition to the bad debt reserve under the specific
charge-off method or the reserve method. Under the reserve method, the addition
to bad debts from losses on loans is computed by use of the experience method.
Use of the experience method requires minimum additions to the reserve based on
the amount allowable under a six-year moving average. The Code also provides
annual limits on the amount the Bank can add to its reserves for loan losses.
State Taxation. Under North Carolina law, the Bank is subject to
corporate income taxes at a 6.90% rate and an annual franchise tax at a rate of
0.15%.
Future Requirements.
Statutes and regulations which contain wide-ranging proposals for
altering the structures, regulations and competitive relationships of financial
institutions are introduced regularly. Neither the Company nor the Bank can
predict whether or what form any proposed statute or regulation will be adopted
or the extent to which the business of the Company or the Bank may be affected
by such statute or regulation.
17
Item 2. Properties
The Company leases or owns seventeen banking offices, as shown in the
following table:
Location Owned or Leased Deposits (1) ATM (2) (3) Year Opened/Purchased
-------- --------------- ------------ ----------- ---------------------
202 South Main Street
Reidsville, North Carolina Owned (4) $ 122,091 Yes 1910 (5)
1646 Freeway Drive
Reidsville, North Carolina Owned 40,465 Yes 1972
202 Turner Drive
Reidsville, North Carolina Owned 36,329 Yes 1969
801 South Van Buren Road
Eden, North Carolina Owned 34,338 Yes 1996
151 North Fieldcrest Road
Eden, North Carolina Leased (expires 2008) 16,535 1996
605 North Highway Street
Madison, North Carolina Owned 22,302 Yes 1997
9570 US 29 Business
Ruffin, North Carolina Leased (expires 2004) 11,152 1997
2132 New Garden Road
Greensboro, North Carolina Owned 37,167 Yes 1997
4638 Hicone Road
Greensboro, North Carolina Owned 17,993 Yes 2000
3202 Randleman Road
Greensboro, North Carolina Owned 17,589 Yes 2000
704 South College Road
Wilmington, North Carolina Leased (expires 2002) 50,758 Yes 1997
7210 Wrightsville Avenue
Wilmington, North Carolina Leased (expires 2003) 1,731 2000
301 East Fremont Street
Burgaw, North Carolina Leased (expires 2004) 26,496 Yes 1999
600 Trent Street
Norton, Virginia Owned 67,545 1973
2302 Second Street
Richlands, Virginia Owned 26,203 1977
700 East Morgan Avenue
Pennington Gap, Virginia Owned 26,103 1979
440 South Main Street
Harrisonburg, Virginia Owned 31,963 1988
(1) Deposits as of December 31, 2001, in thousands of dollars.
(2) Each of the ATMs situated at a banking office is a drive-up ATM.
Three additional remote ATMs are located in Reidsville, North
Carolina, pursuant to leases that expire in 2003.
(3) FNB Southeast owns and operates a network of 38 remote ATMs located
at non-bank locations such as convenience stores and colleges. This
network generally covers the Norton, Virginia region and surrounding
areas.
(4) Consists of 27,000 square feet in a two story building and includes
the Company's executive offices.
(5) Original office opened in different location in 1910. Current
office opened in 1980.
18
Item 3. Legal Proceedings
In the ordinary course of operations, the Company is a party to
various legal proceedings. In the opinion of management, neither the Company nor
the Bank is involved in any pending legal proceedings other than routine,
non-material proceedings occurring in the ordinary course of business.
Item 4. Submission of Matters To a Vote of Security Holders
There were no matters submitted to a vote of the security holders of
the Company during the fourth quarter of the Company's fiscal year ended
December 31, 2001.
19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
Market Prices and Dividend Policies
The Company's common stock is traded on The Nasdaq Stock Market
National Market System under the symbol "FNBF." The following table shows the
high and low sale price of the Company's common stock on The Nasdaq Stock Market
National Market System, based on published financial sources, for each of the
last two fiscal years. The table also reflects the per share amount of dividends
paid for each share during the fiscal quarter for each of the last two fiscal
years. Only one dividend was paid during each of the fiscal quarters listed.
Dividends
Calendar Period High Low Paid
--------------- ---- --- ----
Quarter ended March 31, 2000 $ 13.75 $ 10.13 $ 0.11
Quarter ended June 30, 2000 13.88 10.75 0.11
Quarter ended September 30, 2000 13.00 11.00 0.11
Quarter ended December 31, 2000 12.75 9.56 0.12
Quarter ended March 31, 2001 $ 15.52 $ 10.00 $ 0.12
Quarter ended June 30, 2001 14.20 11.50 0.13
Quarter ended September 30, 2001 15.23 12.70 0.13
Quarter ended December 31, 2001 15.06 13.00 0.13
As of March 12, 2002, there were approximately 1,487 beneficial
owners of the Company's common stock, including 1,249 holders of record of the
Company's common stock. For a discussion as to any restrictions on the Company
or the Bank's ability to pay dividends, reference Item 1 - Supervision and
Regulation of the Company and the Bank.
See also Note 19 in the Notes to Consolidated Financial Statements on
page 60 of this Annual Report on Form 10-K. See also "Supervision and Regulation
- - Regulation of the Company, Dividend and Repurchase Limitations" and
"Regulation of the Bank - Dividends."
Recent Sales of Unregistered Securities
The Company did not sell any securities in the fiscal year ended
December 31, 2001, which were not registered under the Securities Act of 1933,
as amended, except that during such fiscal year the Company granted options to
employees and directors to acquire an aggregate of 126,000 shares of its Common
Stock at a weighted average exercise price of $12.80 per share pursuant to the
Company's Omnibus Equity Compensation Plan.
Item 6. Selected Financial Data
The annual selected historical financial data presented below are
derived from the audited consolidated financial statements for FNB Financial
Services Corporation, FNB Southeast, FNB Southeast Mortgage Corporation and FNB
Southeast Investment Services, Inc. The financial statements of the Company have
been restated for the years prior to 1999 to reflect the acquisition of Black
Diamond on August 31, 1999, in a transaction accounted for as a pooling of
interests. As this information is only a summary, you should read it in
conjunction with the historical financial statements (and related notes) of the
Company and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included elsewhere herein.
20
Item 6. Selected Financial Data
Table 1. Selected Financial Data
(In thousands, except per share, ratio and other data) At and For the Year Ended December 31,
-----------------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
Income Statement Data:
Net interest income $ 21,705 $ 22,659 $ 20,427 $ 18,378 $ 14,598
Provision for credit losses 1,278 2,525 1,401 1,171 686
Other income 4,740 2,891 2,977 3,085 2,146
Other expenses 15,838 16,100 15,193 12,872 10,859
Net income 6,478 4,602 4,248 5,022 3,514
Balance Sheet Data:
Assets $ 704,825 $ 685,904 $ 588,419 $ 549,746 $ 445,990
Loans (1) 535,345 500,637 414,011 362,252 319,467
Allowance for credit losses 6,731 6,311 4,436 3,452 3,185
Deposits 586,760 569,451 484,242 459,595 384,121
Other borrowings 30,000 41,000 31,500 17,500 28,720
Shareholders equity 62,708 56,392 50,730 53,631 30,404
Per Common Share Data (2):
Net income, basic $ 1.43 $ 1.03 $ 0.95 $ 1.19 $ 0.98
Net income, diluted (3) 1.41 1.02 0.93 1.13 0.93
Cash dividends declared 0.51 0.45 0.46 0.30 0.27
Book value 13.72 12.56 11.30 11.81 8.43
Tangible book value 13.65 12.47 11.20 11.68 8.24
Other Data:
Branch offices 17 18 15 14 14
Full-time employees 204 196 189 184 169
Performance Ratios:
Return on average assets 0.91% 0.72% 0.76% 0.97% 0.94%
Return on average equity 10.75 8.96 8.49 11.21
12.49
Net interest margin (tax equivalent) 3.25 3.83 3.88 3.78 4.25
Dividend payout 35.94 44.42 47.98 25.37 27.29
Efficiency (4) 59.05 62.20 64.50 59.50 64.00
Asset Quality Ratios:
Allowance for credit losses to period end loans 1.26% 1.26% 1.07% 0.95% 1.00%
Allowance for credit losses to period end
non-performing loans (5) 297.04 195.87 338.00 221.00 123.00
Net charge-offs to average loans 0.17 0.14 0.11 0.26 -0.03
Non-performing assets to period end loans
and foreclosed property (5) 0.92 0.84 0.45 0.85 0.91
Capital and Liquidity Ratios:
Average equity to average assets 8.45% 8.07% 9.06% 8.69% 7.50%
Leverage 8.64 8.22 9.30 10.30 7.00
Tier 1 risk based 11.58 11.28 13.20 15.30 8.90
Total risk based 12.83 12.53 14.30 16.30 9.90
Average loans to average deposits 85.96 87.91 83.49 79.31 81.50
Average loans to average deposits
and borrowings 79.63 79.22 77.34 74.47 78.12
(1) Loans net of unearned income, before allowance for credit losses.
(2) Gives effect of the 1997 stock split.
(3) Assumes the exercise of outstanding options to acquire common stock. See
Note 15 to the Company's consolidated financial statements.
(4) Computed by dividing non-interest expense by the sum of taxable equivalent
net interest income and non-interest income. (5) Non-performing loans and
non-performing assets include loans past due 90 days or more that are still
accruing interest.
21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion provides information about the major
components of the results of operations and financial condition, liquidity and
capital resources of the Company and should be read in conjunction with the
Company's Consolidated Financial Statements and Notes thereto. See also "Forward
Looking Statements" on page 66 of this Annual Report on Form 10-K.
Overview
The Company earned $6.48 million in 2001, a 40.8% increase over the
$4.60 million earned in 2000. Diluted net income per share of $1.41 for 2001
represents a 38.2% increase over diluted net income per share of $1.02 in 2000.
Total assets at December 31, 2001 stood at $704.8 million compared to $685.9
million one year earlier. The increase in assets is primarily attributable to a
$34.7 million increase in loans, offset by a $22.1 million decrease in
investment securities. Loans at December 31, 2001 totaled $535.3 million and
investment securities totaled $123.6 million.
During 2001, deposits increased 3.0% to $586.7 million at December
31, 2001. Total purchased funds at December 31, 2001 totaled $49.7 million
compared to $53.5 million at the prior year-end. Shareholders' equity increased
11.2% to $62.7 million at current year-end. Book value per share was $13.72
compared to $12.56 one year earlier.
The Company's subsidiary bank, FNB Southeast, is a North Carolina
chartered commercial bank and currently operates thirteen banking offices in
North Carolina and four banking offices in Virginia. FNB Southeast operates two
wholly owned subsidiaries. FNB Southeast Investment Services, Inc. was formed in
2000 to provide retail investment products and services. FNB Southeast Mortgage
Corporation was formed in 2001 and acquired certain assets of Airlee Mortgage
Corporation, which provide mortgage banking services.
Results of Operations
Net interest income represents the gross profit from the lending and
investment activities of a banking organization and is the most significant
factor affecting the earnings of the Company. Net interest income is influenced
by changes in interest rates, volume and the mix of these various components.
Net interest income on a fully taxable equivalent basis for 2001 was $22.1
million, which represented a 4.0% decrease from the previous year. In 2000,
taxable equivalent net interest income increased to approximately $23.0 million
from approximately $20.6 million in 1999. Actual net interest income for 2001
was $21.7 million, a 4.2% decrease from $22.7 million recorded in 2000. The
decrease in net interest income is primarily attributable to the decline in the
earning asset rate resulting from the dramatic reduction in the prime lending
rate throughout 2001. The prime lending rate declined from 9.50% at December 31,
2000 to 4.75% at December 31, 2001. The rate decline was partially offset by
increased balances of interest earning assets. Average loans outstanding during
the 2001 fiscal year were $515.3 million compared to $459.7 million in 2000, an
increase of 12.1%. In the previous year, average loans outstanding were 18.7%
higher than 1999. Average investment securities during 2001 were $157.4 million
compared to $135.8 million in 2000 and $136.5 million in 1999.
Trends in interest rates were sharply downward for the year as the
Federal Reserve decreased interest rates throughout 2001. This had the effect of
decreasing both the earning asset yield and the interest bearing liability rate.
During the year the decline in the earning asset yield outpaced the decline in
the interest bearing liability rate. However, the decline in interest rates did
result in an increase in the fair value of the Company's investment portfolio.
The increased fair value resulted in increased liquidity, due to securities
being called and the sale of securities at a gain.
22
The weighted average yield on earning assets decreased 98 basis
points to 7.75% for 2001 compared to 8.73% for 2000 and 8.05% for 1999. This
decrease in the asset yield in 2001 was primarily attributable to the decreased
yield on loans. During the current year, the yield on loans decreased 112 basis
points to 8.36% from 9.48% in 2000. This decline is due to variable rate loans
that repriced lower throughout the year in response to decreases in the
underlying index.
The weighted average rate paid on interest bearing liabilities of
4.86% in 1999 had increased to 5.58% in 2000, but fell to 5.18% in 2001, a
decrease of 40 basis points. Average interest bearing deposits for 2001 totaled
$544.1 million and totaled $472.1 million in 2000. This represents an increase
of $72.0 million, or 15.3% from $472.1 million in average balances from 2000.
The overall rate for interest bearing deposits decreased 28 basis points to
5.19% in 2001 compared to 5.47% in the prior year.
The overall rate on purchased funds decreased 150 basis points during
2001. Average purchased funds totaled $47.6 million in 2001, with an average
rate of 4.97%. This is a $9.7 million decrease from one year earlier. This
decrease was primarily attributable to reduced levels of FHLB advances utilized
during 2000. In 1999, average purchased funds was $36.9 million. Average FHLB
borrowings for 2001 was $34.4 million compared to $45.6 million in 2000. The
average rate paid on purchased funds was 4.97%, 6.47% and 5.18% for 2001, 2000
and 1999 respectively.
Table 2 on page 32 summarizes net interest income and average yields
earned and rates paid for the years indicated, on a tax equivalent basis. Table
3 on page 33 presents the changes in interest income and interest expense
attributable to volume and rate changes between 2001 and 2000, and between 2000
and 1999.
Non-interest Income and Expense
Non-interest income of $4.7 million in 2001 was $1.8 million, or
64.0%, more than the previous year amount of $2.9 million. In 1999, non-interest
income was $3.0 million. One category of noninterest income, gain on sale of
securities, experienced significant increases in 2001 compared to 2000 due to
changes in the interest rate environment during the year. Gains on sale of
securities for 2001 totaled $1.8 million, up from $60,000 in 2000 and $118,000
in 1999. Service charges on deposit accounts increased to $2.2 million from $2.1
million in 2000 and $1.8 million in 1999. The Company was able to capitalize on
increased fees and increased volume of demand deposits and other accounts with
service charges.
Personnel expense of $9.3 million in 2001, exceeded the previous year
by $582,000, or 6.7%. Personnel expense in 1999 was $8.2 million. At December
31, 2001, the Company had approximately 204 full-time and 8 part-time employees,
compared with 196 full-time and 12 part-time employees at December 31, 2000.
Occupancy expenses totaled $1.0 million for 2001, which was up 18.6% from
$871,000 in 2000. Furniture and equipment expenses totaled $1.8 million in the
current year, a 22.4% increase from $1.5 million recorded in 2000. The
efficiency ratio, which measures non-interest expense as a percentage of net
interest income plus non-interest income, was 59.1% in 2001, and compared
favorably to the 62.2% efficiency ratio posted in 2000 and 64.5% in 1999. Other
expenses were $2.8 million compared to $3.9 million in 2000. The decrease is
primarily due to the reversal of $260,000 of other expenses in 2001 of a
$350,000 expense recorded in 2000. The expense was recorded in 2000 based on the
best estimate of cost to cancel a contract with a third party data processing
service provider. The contract was cancelled during 2001 and the actual cost was
approximately $90,000.
Income tax expense in 2001 was $2.9 million, an increase from $2.3
million in 2000. The effective tax rate in 2001 decreased to 30.6% from 33.6% in
2000. The decline in the effective tax rate for 2001 is primarily due to the
reduced current expense required to provide adequate income tax provision at the
year-end 2001. Income tax expense in 1999 was $2.6 million, with an effective
rate of 37.6%. The higher effective tax rate in 1999 was primarily attributable
to nondeductible merger-related cost incurred during that year.
23
Financial Condition
The Company's consolidated assets of $704.8 million at year end
increased 2.8% over the previous year, following an increase of 16.6% in 2000.
Total average assets increased 12.1% to $713.5 million in 2001, compared to
$636.2 million in 2000. During 2001 the Company experienced a 13.5% increase in
average earning assets. Average earning assets totaled $680.5 million in 2001
compared to $602.3 million in 2000. The increase in 2001 was driven by an
increase in average outstanding loans, but mitigated by a decrease in average
investment securities balance. Growth in earning assets was supported by an
increase of 8.8% in average non-interest bearing deposits, and a 15.3% in
interest bearing deposits.
Loan growth during 2001 was $34.7 million, with outstanding loans up
6.9% at year-end, which followed increases of 20.9% in 2000 and 14.3% in 1999.
Loans secured by real estate increased to $354.5 million in 2001 and represented
66.3% of total loans, compared with 67.2% at year end 2000. Within this
category, commercial real estate loans increased 40.8% during fiscal 2001 to a
level of $168.4 million. Commercial, financial and agricultural loans totaled
$90.9 million and represent 17.0% of total loans, compared with 15.0% last
year-end. Consumer loans increased 1.0% during fiscal 2001 led by increased home
equity loans. Management believes the Company is not dependent on any single
customer or group of customers concentrated in a particular industry, the loss
of whose deposits or whose insolvency would have a material adverse effect on
operations.
Investment securities (at amortized cost) of $125.1 million at
year-end 2001 were down $24.3 million, or 16.3%, from year-end 2000. U.S.
Government agency securities continue to represent the major share of the total
portfolio, and totaled $112.5 million, or 89.9% of the portfolio at year-end
2001, compared to $127.9 million, or 85.6% of the portfolio one year earlier.
Management believes that the additional risk of owning agency securities over
U.S. Treasury securities is negligible and has capitalized on the favorable
spreads available on the former. State and municipal obligations decreased $7.8
million and stood at $8.3 million at year-end. The Company's investment strategy
is to achieve acceptable total returns, while investing in securities with
relatively short maturity dates as necessary to fund loan growth. To this end,
the Company has consistently categorized the entire portfolio as "Available for
Sale," which it believes offers the greatest amount of flexibility in managing a
total return concept. Table 4 on page 34 presents the composition of the
securities portfolio for the last three years, as well as information about
cost, fair value and weighted average yield.
Total deposits increased $17.3 million to $586.8 million at December
31, 2001. This is a 3.0% increase over $569.5 million in deposits one year
earlier. A $2.6 million, or 0.6%, increase in time deposits and a $4.4 million,
or 8.1%, increase in demand deposits drove the annual increase during fiscal
2001. Savings, NOW and MMI accounts decreased by $10.3 million to $93.0 million
at 2001 year-end.
The market for deposits remains fiercely competitive and the Company
relies on appropriate pricing and quality customer service to retain and
increase its retail deposit base. During the year, the Company had several
featured products to generate new deposits and increase the customer base. For
commercial customers, the Company is focused on building a total relationship,
which will foster growth in both loans and deposits. In addition to traditional
checking accounts, the Company offers a cash management sweep account, with
outstanding balances of $9.9 million at year end.
In order to attract additional deposits, the Company maintains
membership in an electronic network that allows it to post interest rates and
attract deposits nationally. As of December 31, 2001, FNB Southeast had
approximately 188 of such certificates of deposit totaling $20.7 million, with
an overall rate of 5.17% for this portfolio. This certificate portfolio
decreased by $10.0 million during 2001. The Company also held $17.0 million in
brokered certificates of deposit at December 31, 2001 compared to $22.0 million
one year earlier. The brokered certificates have an original term of twelve
months with maturities scheduled for January and April 2002.
24
The Company also has a credit facility with the Federal Home Loan
Bank of Atlanta. Borrowing capacity is established at 17% of the subsidiary
banks' total assets as submitted on regulatory financial reports. The Company
also utilized a portion of its approximately $115 million line with the Federal
Home Loan Bank of Atlanta to fund earning assets. FHLB borrowings totaled $30.0
million at year-end. Management continues to believe this is a cost effective
and prudent alternative to deposit balances, since a particular amount, term and
structure may be selected to meet its current needs.
Asset Quality
Management places great emphasis on maintaining the Company's asset
quality. The allowance for credit losses, which is utilized to absorb actual
losses in the loan portfolio, is maintained at a level consistent with
management's best estimate of probable loan losses incurred as of the balance
sheet date.
The loan portfolio is analyzed on an ongoing basis to evaluate
current risk levels, and risk grades are adjusted accordingly. The Company's
allowance for credit losses is also analyzed quarterly by management. This
analysis includes a methodology that separates the total loan portfolio into
homogeneous loan classifications for purposes of evaluating risk. The required
allowance is calculated by applying a risk adjusted reserve requirement to the
dollar volume of loans within a homogenous group. Major loan portfolio subgroups
include: risk graded commercial loans, mortgage loans, home equity loans, retail
loans and retail credit lines. The provisions of Statement of Financial
Accounting Standard No. 114 ("SFAS No. 114") and related pronouncements are
applied to individually significant loans. Finally, individual reserves may be
recorded based on a review of loans on the "watch list."
Commercial loans. All commercial loans within the portfolio are risk
graded among nine risk grades based on management's evaluation of the overall
credit quality of the loan, including the payment history, the financial
position of the borrower, the underlying collateral value, an internal credit
risk assessment and examination results. There is an increased reserve
percentage for each successively higher risk grade. As a result, the allowance
is adjusted upon any migration of a loan to a higher risk grade within the
commercial loan portfolio. The following table details the risk-graded portfolio
at December 31, 2001 and 2000.
Risk Percent of Commercial Risk General
Grade Description Loans by Grade Reserve Percentage
- ----- ----------- ---------------------------- ----------------------------
2001 2000 2001 2000
---- ---- ---- ----
Risk 1 Low Risk 0.62 % 0.54 % 0.00% 0.00%
Risk 2 Lower Than Average Risk 1.09 1.46 0.25 0.25
Risk 3 Average Risk 15.33 24.38 0.45 0.45
Moderately Higher Than
Risk 4 Average Risk 76.50 68.39 0.80 0.80
Risk 5 Higher Than Average Risk 2.23 0.16 1.25 1.25
Risk 6 Special Mention 1.31 0.66 2.50 2.50
Risk 7 Substandard 2.90 4.15 15.00 15.00
Risk 8 Doubtful 0.03 0.26 50.00 50.00
Risk 9 Loss 0.00 0.00 100.00 100.00
25
The reserve percentages utilized have been determined by management
to be appropriate based on historical loan loss levels and the risk for each
corresponding risk grade. During 2000, the Company reviewed the reserve
percentages for commercial risk graded loans. The change in the reserve
percentages in risk grade 2 through risk grade 5 was made to better reflect the
historical charge-off experience of the Company. The reserve percentages for
risk grades 6, risk grade 7, risk grade 8 and risk grade 9 were changed to
reserve percentages preferred by banking regulators. The net effect in 2000,
compared to earlier years, was to reserve a higher overall percentage for risk
grade 6 through risk grade 9, and a lower overall percentage for risk grade 1
through risk grade 5. The reserve percentages established in 2000 remained in
effect throughout 2001.
Mortgage, home equity, and credit lines. Reserves are calculated on
mortgage, home equity, and credit lines based on historical loss experience and
current economic conditions. The average rolling eight-quarter net loss
percentage is calculated for each of these loan categories. The reserve
requirement also includes a reserve percentage for current economic conditions.
The sum of these two components is applied to the dollar balance of loans in
each of these categories to determine the required reserve.
Retail loans. The retail loans are pooled together to determine the
reserve requirement. The average rolling eight-quarter net loss percentage is
calculated for this loan category. The reserve requirement also includes a
reserve percentage for current economic conditions. The sum of these two
components is applied to the dollar balance of retail loans to determine the
required reserve for current loans and loans past due less than 90 days. A
separate reserve is calculated for loans past due 90 days or more. A reserve
amount equal to 25.0% of all retail loans past due 90 days or more is added to
the above mentioned requirement to determine the total reserve requirement for
retail loans.
Specific impairment under SFAS No. 114. Management evaluates
individually significant loans in risk grade 7 and risk grade 8 on an individual
basis for impairment. The specific allowance is calculated based upon a review
of these loans and the estimated losses at the balance sheet date. At December
31, 2001 and 2000, the recorded investment in loans considered impaired was
approximately $6,857,000 and $3,222,000, respectively. Impaired loans at
December 31, 2001 consisted of $924,000 of retail loans past due 90 days or
more, and $5,933,000 of risk grade 7 and risk grade 8 commercial loans.
Calculated reserves for impaired loans at December 31, 2001 totaled $1,748,000
and $901,000 one year earlier.
Risk grade 9 loans are evaluated on an individual basis. Since these
loans are considered a loss, a reserve percentage of 100% of the outstanding
balance is required. The Company had no loans risk graded 9 at December 31,
2001.
Watch list review. Specific allowances may be determined based on a
review of specific watch list loans. Specific losses are estimated at each
measurement date. The Company has established a monthly procedure to review all
loans placed on the watch list. The watch list primarily consist of loans
classified as special mention, substandard and doubtful. An estimated loss
amount and action plan is established for each watch list loan. By reviewing
these watch list loans, the Company is able to update original probable loss
amounts in light of developing conditions. This serves to reduce the differences
between estimated and actual observed losses.
The 2001 provision for credit losses of $1.3 million compares with
$2.5 million in 2000, which equals an 49.4% decrease in 2001. In the fourth
quarter of 2000 the Company recorded a provision for credit losses of $1.3
million. This action was taken as part of the Company's continuing evaluation of
the loan portfolio and other credit risk factors. During 2001 credit quality
remained good, and the levels of non-performing loans and charge-offs have
remained at comparatively low levels. Net charge-offs increased in 2001 to
$858,000 or 0.17% of average loans outstanding, compared with $650,000 or 0.14%
of average loans outstanding in the prior year. At December 31, 2001 the
allowance for credit losses as a percentage of year end loans was 1.26%, the
same as at December 31, 2000.
26
During 2001 and at December 31, 2001, the Company observed a
migration in the risk graded commercial loan portfolio to risk grades indicative
of higher credit risk. Specifically, as indicated in the table above, there was
a migration from risk grade 3 to risk grade 4 and risk grade 5. This migration
was partially offset by a decrease in retail loans past due 90 days or more from
those existing at December 31, 2000.
Risk grade loans classified special mention, substandard and doubtful
decreased from $13.8 million at year-end 2000 to $13.1 million at year-end 2001.
The reserve requirement for this category of loans totaled $2.1 million for both
years. Retail loans past due 90 days or more at December 31, 2001 were $924,000,
with a $391,000 reserve requirement. This compares to $1,564,000 in retail loans
past due 90 days or more and a reserve requirement of $391,000 at December 31,
2000.
The table below summarizes the Company's allowance as a percentage of
total loans outstanding and net charge-off percentage for the past five years.
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Allowance percentage 1.26 % 1.26 % 1.07 % 0.95 % 1.00 %
Net charge-off percentage 0.17 % 0.14 % 0.11 % 0.26 % (0.03)%
Non-performing assets include non-accrual loans, accruing loans
contractually past due ninety days or more, restructured loans, and other real
estate. Loans are placed on non-accrual status when: (i) management has concerns
relating to the ability to collect the loan principal and interest and (ii)
generally when such loans are ninety days or more past due. No assurance can be
given, however, that economic conditions will not adversely affect borrowers and
result in increased credit losses.
Capital Resources
Banks and financial holding companies, as regulated institutions,
must meet required levels of capital. The Federal Reserve has adopted minimum
capital regulations or guidelines that categorize components and the level of
risk associated with various types of assets. Financial institutions are
required to maintain a level of capital commensurate with the risk profile
assigned to its assets in accordance with the guidelines. As shown in Table 7 on
page 37, the Company and the Subsidiary Bank both maintained capital levels
exceeding the minimum levels to be "well capitalized" for the three years
presented. Effective in March 1999, FNB Southeast converted from a national
bank, regulated by the Office of the Comptroller of the Currency, to a North
Carolina bank, regulated by the Commissioner. FNB Southeast will continue to be
required to meet certain levels of capital.
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash
flow requirements based primarily on activity in loan and deposit accounts of
the Company's customers. Deposit withdrawals, loan funding and general corporate
activity create a need for liquidity for the Company. Liquidity is derived from
sources such as deposit growth; maturity, calls, or sales of investment
securities; principal and interest payments on loans; access to borrowed funds
or lines of credit; and profits. The investment portfolio at December 31, 2001,
held securities with call features, whereby the issuer of such a security has
the option to repay the purchaser of said instrument and cancels the instrument
before the contractual maturity date. Due to the interest rate on the original
instrument and current market rates on such instruments, the Company anticipates
that certain debt instruments in the portfolio may be called in the upcoming
year.
During 2001, the Company deployed cash flow from operating and
financing activities to fund increases in the loan portfolio. Overall, cash and
cash equivalents increased by $8.1 million to $23.4 million at December 31,
2001.
27
As presented in the consolidated statement of cash flows, the Company
generated $6.9 million in operating cash flow during 2001, down 8.4% from $7.6
million in 2000. This decrease was primarily attributable to a decrease in the
amount that interest received exceeded interest paid in each year. In 2001, the
excess was only $20.7 million, while in 2000, the excess was $21.8 million. This
change resulted from the falling interest rate environment in 2001, and the
Company's inability to decrease rates paid on deposits as quickly as the yield
on loans dropped.
In 2001, the Company had a net increase of $37.2 million in loans
compared to $88.8 million in 2000. In 2001, the Company received $154.4 million
from sales and calls of securities, while purchasing $149.4 million. The
turnover in the security portfolio was attributable to the reduction in interest
rates throughout the year. In 2000, the Company purchased $19.7 million of
securities, while receiving $6.3 million from sales and calls and $588,000 from
maturities.
The Company's major financing sources during 2001 were a $14.7
million increase in savings, NOW and MMI deposits and a $2.6 million increase in
time deposits, for a combined total of $17.3 million. This is lower than the
combined $85.2 million increase in deposits during 2000. The deposit growth
during the year allowed the Company to reduce FHLB borrowings by $11.0 million.
Time deposits increased $16.4 million and borrowings increased $14.0 million in
1999.
Liquidity is further enhanced by an approximately $115 million line
of credit with the Federal Home Loan Bank of Atlanta (FHLB) collateralized by
FHLB stock, investment securities and qualifying 1 to 4 family residential
mortgage loans. The Company provides various reports to the FHLB on a regular
basis throughout the year to maintain the availability of the credit line. Each
borrowing request to the FHLB is initiated through an advance application that
is subject to approval by the FHLB before funds are advanced under the credit
agreement.
The Company also has unsecured overnight borrowing lines totaling $19
million available through four financial institutions. These lines are used to
manage the day to day, short-term liquidity needs of the Company. Each Federal
funds line has a requirement to repay the line in full on a frequent basis,
typically within five to ten business days.
The Company also projects future cash flow requirements based on
scheduled loan and deposit maturities, borrowing maturities, capital
expenditures and other factors. At December 31, 2001 and for the upcoming twelve
month period, the Company had scheduled loan maturities of $135.8 million,
securities maturities of $145,000 and $340.5 million in maturing time deposits.
The Company also has $93.0 million in deposits with no contractual maturity that
are subject to withdrawal during 2002. The Company also has $34.7 of borrowings
that are scheduled for repayment in 2002. Anticipated capital expenditures
during 2002 are approximately $1.5 million. Internal analysis indicated the
Company is positioned to meet expected liquidity requirements during the
upcoming twelve-month period.
The Company also has off-balance sheet arrangements with customers