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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission File Number 0-15572
FIRST BANCORP
(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
(State of Incorporation) (I.R.S. Employer Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (910) 576-6171
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
(Title of each class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. |X| YES |_| NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy of information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to the Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). |X| YES |_| NO
The aggregate market value of the voting stock, Common Stock, no par
value, held by non-affiliates of the registrant, based on the average bid and
asked prices of the Common Stock as of the last trading day prior to June 30,
2002 as reported on the NASDAQ National Market System, was approximately
$194,803,000. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
The number of shares of the Registrant's Common Stock outstanding on
February 14, 2003 was 9,375,660.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed pursuant to
Regulation 14A are incorporated herein by reference into Part III.
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CROSS REFERENCE INDEX
Begins on
Page (s)
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PART I
Item 1 Business 4
Item 2 Properties 11
Item 3 Legal Proceedings 11
Item 4 Submission of Matters to a Vote of Shareholders 12
PART II
Item 5 Market for the Registrant's Common Stock and Related
Shareholder Matters 12
Item 6 Selected Consolidated Financial Data 12, 43
Item 7 Management's Discussion and Analysis of Results of
Operations and Financial Condition 12
Critical Accounting Policies 12
Discussion Regarding Impact of Accounting Methods Used
in Mergers and Acquisitions 13
Merger and Acquisition Activity 14
Note Regarding Pro Forma Information 17
Statistical Information
Net Interest Income 20, 44
Average Balances and Net Interest Income Analysis 20, 44
Volume and Rate Variance Analysis 20, 45
Provision for Loan Losses 22, 50
Noninterest Income 23, 45
Noninterest Expenses 24, 45
Income Taxes 25, 46
Distribution of Assets and Liabilities 27, 46
Securities 27, 46
Loans 29, 48
Nonperforming Assets 29, 49
Allowance for Loan Losses and Loan Loss Experience 31, 49
Deposits 33, 51
Borrowings 34
Liquidity 34, 52
Interest Rate Risk (Including Quantitative
and Qualitative Disclosures About Market Risk) 36, 52
Return on Assets and Equity 37, 53
Capital Resources and Shareholders' Equity 37, 53
Inflation 39
Current Accounting Matters 40
Item 7A Quantitative and Qualitative Disclosures About Market Risk 42
Forward-Looking Statements 42
Item 8 Financial Statements and Supplementary Data:
Consolidated Balance Sheets as of December 31, 2002 and 2001 55
Consolidated Statements of Income for each of the years in the
three-year period ended December 31, 2002 56
Consolidated Statements of Comprehensive Income for each of the
years in the three-year period ended December 31, 2002 57
2
Begins on
Page (s)
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Consolidated Statements of Shareholders' Equity for each of the years
in the three-year period ended December 31, 2002 58
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended December 31, 2002 59
Notes to Consolidated Financial Statements 60
Independent Auditors' Report 88
Selected Consolidated Financial Data 43
Quarterly Financial Summary 54
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 89
PART III
Item 10 Directors and Executive Officers of the Registrant; Compliance
with Section 16 (a) of the Exchange Act 89*
Item 11 Executive Compensation 89*
Item 12 Security Ownership of Certain Beneficial Owners and Management 89*
Item 13 Certain Relationships and Related Transactions 89*
Item 14 Controls and Procedures 89
Item 15 Exhibits, Financial Statement Schedules and Reports of Form 8-K 89
SIGNATURES 92
CERTIFICATIONS 94
* Information called for by Part III (Items 10 through 13) is incorporated
herein by reference to the Registrant's definitive Proxy Statement for the
2003 Annual Meeting of Shareholders to be filed with the Securities and
Exchange Commission.
3
PART I
Item 1. Business
General Description
The Company
First Bancorp (the "Company") is a bank holding company. The principal
activity of the Company is the ownership and operation of First Bank (the
"Bank"), a state chartered bank with its main office in Troy, North Carolina.
The Company also owns and operates three nonbank subsidiaries, Montgomery Data
Services, Inc. ("Montgomery Data"), a data processing company, First Bancorp
Financial Services, Inc. ("First Bancorp Financial"), which owns and operates
various real estate, and First Bancorp Capital Trust I, a statutory business
trust created under the laws of the State of Delaware, that issued $20 million
in debt securities in October 2002. All of the Company's subsidiaries are fully
consolidated for financial reporting purposes.
The Bank has two wholly-owned subsidiaries, First Bank Insurance Services,
Inc. and First Montgomery Financial Services Corporation. First Bank Insurance
Services, Inc. ("First Bank Insurance") was acquired as an active insurance
agency in 1994 in connection with the Company's acquisition of a bank that had
an insurance subsidiary. On December 29, 1995, the insurance agency operations
of First Bank Insurance were divested. From December 1995 until October 1999,
First Bank Insurance was inactive. In October 1999, First Bank Insurance began
operations again as a provider of non-FDIC insured investments and insurance
products. First Montgomery Financial Services Corporation ("First Montgomery"),
a Virginia company incorporated on November 2, 2001, was formed to acquire real
estate in Virginia and lease the property to the Bank. First Troy Realty
Corporation ("First Troy") was incorporated on May 12, 1999 and is a subsidiary
of First Montgomery. First Troy allows the Bank to centrally manage a portion of
its residential, mortgage, and commercial real estate loan portfolio.
The Company was incorporated in North Carolina on December 8, 1983, as
Montgomery Bancorp, for the purpose of acquiring 100% of the outstanding common
stock of the Bank through stock-for-stock exchanges. On December 31, 1986, the
Company changed its name to First Bancorp to conform its name to the name of the
Bank, which had changed its name from Bank of Montgomery to First Bank in 1985.
The Bank was organized in 1934 and began banking operations in 1935 as the
Bank of Montgomery, named for the county in which it operated. As of December
31, 2002, the Bank operated in a 16 county area centered in Troy, North
Carolina. Troy, population 3,400, is located in the center of Montgomery County,
approximately 60 miles east of Charlotte, 50 miles south of Greensboro, and 80
miles southwest of Raleigh. The Bank conducts business from 48 branches located
primarily within an 80-mile radius of Troy, covering principally a geographical
area from Maxton to the southeast, to High Point to the north, Kannapolis to the
west, and Lillington to the east. The Bank also has a branch in Wytheville,
Virginia, which is 30 miles north of the North Carolina/Virginia border. The
Bank operates under the name "First Bank of Virginia" in the Wytheville branch.
Ranked by assets, the Bank is the 7th largest bank in North Carolina as of
December 31, 2002.
On September 14, 2000, the Company completed the merger acquisition of
First Savings Bancorp, Inc. ("First Savings"). This merger was material to the
Company. The merger was accounted for as a pooling-of-interests and accordingly,
all financial results for prior periods have been restated to include the
combined results of the Company and First Savings. At the time of the merger,
First Savings had approximately $310 million in assets, and in connection with
the merger the Company issued approximately 4.4 million shares of stock, nearly
doubling its number of shares outstanding. For information about other merger
and acquisition activity, including two acquisitions completed after December
31, 2002, see "Merger and Acquisition Activity" under Item 7 - Management's
Discussion and Analysis of Results of Operations and Financial Condition.
4
The Bank provides a full range of banking services, including the
accepting of demand and time deposits, the making of secured and unsecured loans
to individuals and businesses, and the offering of credit cards and debit cards.
In 2002, as in recent prior years, the Bank accounted for substantially all of
the Company's consolidated net income.
The Company's principal executive offices are located at 341 North Main
Street, Troy, North Carolina 27371-0508, and its telephone number is (910)
576-6171. Unless the context requires otherwise, references to the "Company" in
this annual report on Form 10-K shall mean collectively First Bancorp and its
subsidiaries.
General Business
The Bank engages in a full range of banking activities, providing such
services as checking, savings, NOW and money market accounts and other time
deposits of various types; loans for business, agriculture, real estate,
personal uses, home improvement and automobiles; credit cards; debit cards;
letters of credit; IRA's; safe deposit box rentals; bank money orders; and
electronic funds transfer services, including wire transfers, automated teller
machines, and bank-by-phone capabilities. Because the majority of the Bank's
customers are individuals and small to medium-sized businesses located in the
counties it serves, management does not believe that the loss of a single
customer or group of customers would have a material adverse impact on the Bank.
There are no seasonal factors that tend to have any material effect on the
Bank's business, and the Bank does not rely on foreign sources of funds or
income. Because the Bank operates primarily within the central Piedmont region
of North Carolina, the economic conditions within that area could have a
material impact on the Company - see additional discussion below in the section
entitled "Territory Served and Competition."
Beginning in 1999, First Bank Insurance began offering non-FDIC insured
investment and insurance products, including mutual funds, annuities, long-term
care insurance, life insurance, and company retirement plans, as well as
financial planning services. In May 2001, First Bank Insurance added to its
product line when it acquired two insurance agencies that specialized in the
placement of property and casualty insurance. First Bank Insurance collects
commissions for the services it provides.
Montgomery Data's primary business is to provide electronic data
processing services for the Bank. Ownership and operation of Montgomery Data
allows the Company to do all of its electronic data processing without paying
fees for such services to an independent provider. Maintaining its own data
processing system also allows the Company to adapt the system to its individual
needs and to the services and products it offers. Although not a significant
source of income, Montgomery Data has historically made its excess data
processing capabilities available to area financial institutions for a fee.
Montgomery Data now has four outside customers that provided gross revenues of
$303,000, $205,000, and $117,000 for the years ended December 31, 2002, 2001,
and 2000, respectively.
First Bancorp Financial was organized under the name of First Recovery in
September of 1988 for the purpose of providing a back-up data processing site
for Montgomery Data and other financial and non-financial clients. First
Recovery's back-up data processing operations were divested in 1994. First
Bancorp Financial now owns and leases the First Recovery building. First Bancorp
Financial periodically purchases parcels of real estate from the Bank that were
acquired through foreclosure or from branch closings. The parcels purchased
consist of real estate having various purposes. First Bancorp Financial actively
pursues the sale of these properties.
First Bancorp Capital Trust I was organized in October 2002 for the
purpose of issuing $20 million in debt securities. These borrowings are due on
November 7, 2032 and were structured as trust preferred capital securities,
which qualify as Tier I capital for regulatory capital adequacy requirements.
These debt securities are callable by the Company at par on any quarterly
interest payment date beginning on November 7, 2007. The interest rate on these
debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus
3.45%. This rate may not exceed 12.50% through November 2007.
5
First Montgomery was incorporated on November 2, 2001. First Montgomery's
business activities are currently limited to the selection and acquisition of
real estate in Virginia that is leased to the Bank for use as bank branches.
First Troy was incorporated on May 12, 1999 as a subsidiary of the Bank.
Upon the formation of First Montgomery as a subsidiary of the Bank, the Bank
contributed its interest in First Troy to First Montgomery, resulting in First
Troy becoming a subsidiary of First Montgomery. First Troy allows the Bank to
centrally manage a portion of its residential, mortgage, and commercial real
estate loan portfolio. First Troy has elected to be treated as a real estate
investment trust for tax purposes.
Territory Served and Competition
The Company's headquarters are located in Troy, Montgomery County. The
Company serves primarily the south central area of the Piedmont region of North
Carolina, with offices in 16 counties. The following table presents, for each
county the Company operates in, the number of bank branches operated by the
Company within each of those counties, the approximate amount of deposits with
the Company in each county as of December 31, 2002, the Company's approximate
market share, and the number of bank competitors located in the county.
No. of Deposits Market Number of
County Branches (in millions) Share Competitors
------ -------- ------------- ----- -----------
Anson 1 $ 11 5.2% 4
Cabarrus 2 22 1.2% 6
Chatham 2 35 7.5% 9
Davidson 2 100 6.5% 9
Guilford 1 32 0.5% 20
Harnett 3 71 9.0% 7
Lee 3 93 12.5% 6
Montgomery 5 84 33.7% 4
Moore 10 296 26.0% 10
Randolph 4 47 3.2% 11
Richmond 1 19 4.1% 4
Robeson 4 87 11.6% 9
Rowan 2 39 3.0% 10
Scotland 2 41 14.4% 5
Stanly 4 64 8.9% 5
Wake 1 6 0.0% 17
Wythe, VA 1 9 1.6% 8
-- ------
Total 48 $1,056
== ======
The Company's 48 branches and facilities are primarily located in small
communities whose economies are based primarily on services, manufacturing and
light industry. Although the Company's market is predominantly small communities
and rural areas, the area is not dependent on agriculture. Textiles, furniture,
mobile homes, electronics, plastic and metal fabrication, forest products, food
products and cigarettes are among the leading manufacturing industries in the
trade area. Leading producers of socks, hosiery and area rugs are located in
Montgomery County. The Pinehurst area within Moore County is a widely known golf
resort and retirement area. The High Point area is widely known for its
furniture market. Additionally, several of the communities served by the Company
are "bedroom" communities serving Charlotte and Greensboro in addition to
smaller cities such as Albermarle, Asheboro, High Point, Pinehurst and Sanford.
As shown in the table above, approximately 28% of the Company's deposit
base is in Moore County, and, accordingly, material changes in competition, the
economy or population of Moore County could materially impact the Company. No
other county comprises more than 10% of the Company's deposit base.
The Company competes in its various market areas with, among others,
several large interstate bank holding
6
companies that are headquartered in North Carolina. These large competitors have
substantially greater resources than the Company, including broader geographic
markets, higher lending limits and the ability to make greater use of
large-scale advertising and promotions. A significant number of interstate
banking acquisitions have taken place in the past decade, thus further
increasing the size and financial resources of some of the Company's
competitors, three of which are among the largest bank holding companies in the
nation. Moore County, which as noted above comprises a disproportionate share of
the Company's deposits, is a particularly competitive market, with at least ten
other financial institutions having a physical presence. See "Supervision and
Regulation" below for a further discussion of regulations in the Company's
industry that affect competition.
The Company competes not only against banking organizations, but also
against a wide range of financial service providers, including federally and
state chartered savings and loan institutions, credit unions, investment and
brokerage firms and small-loan or consumer finance companies. Competition among
financial institutions of all types is virtually unlimited with respect to legal
ability and authority to provide most financial services. The Company also
experiences competition from internet banks, particularly as it relates to time
deposits.
However, the Company believes it has certain advantages over its
competition in the areas it serves. The Company seeks to maintain a distinct
local identity in each of the communities it serves and actively sponsors and
participates in local civic affairs. Most lending and other customer-related
business decisions can be made without delays often associated with larger
systems. Additionally, employment of local managers and personnel in various
offices and low turnover of personnel enable the Company to establish and
maintain long-term relationships with individual and corporate customers.
Lending Policy and Procedures
Conservative lending policies and procedures and appropriate underwriting
standards are high priorities of the Bank. Loans are approved under the Bank's
written loan policy, which provides that lending officers, principally branch
managers, have authority to approve loans of various amounts up to $100,000.
Each of the Bank's regional senior lending officers has discretion to approve
secured loans in principal amounts up to $350,000 and together can approve loans
up to $2,000,000. Lending limits may vary depending upon whether the loan is
secured or unsecured.
The Bank's board of directors reviews and approves loans that exceed
management's lending authority, loans to officers, directors, and their
affiliates and, in certain instances, other types of loans. New credit
extensions are reviewed daily by the Bank's senior management and at least
monthly by the board of directors.
The Bank continually monitors its loan portfolio to identify areas of
concern and to enable management to take corrective action. Lending officers and
the board of directors meet periodically to review past due loans and portfolio
quality, while assuring that the Bank is appropriately meeting the credit needs
of the communities it serves. Individual lending officers are responsible for
pursuing collection of past-due amounts and monitoring any changes in the
financial status of the borrowers.
The Bank's internal audit department evaluates specific loans and overall
loan quality at individual branches as part of its regular branch reviews. The
Bank also contracts with an independent consulting firm to review new loan
originations meeting certain criteria, as well as assign risk grades to existing
credits meeting certain thresholds. The consulting firm's observations,
comments, and risk grades, including variances with the Bank's risk grades, are
shared with the Company's audit committee of the board of directors, and are
considered by management in setting Bank policy, as well as in evaluating the
adequacy of the allowance for loan losses. See "Allowance for Loan Losses and
Loan Loss Experience" in Item 7 below.
7
Investment Policy and Procedures
The Company has adopted an investment policy designed to optimize the
Company's income from funds not needed to meet loan demand in a manner
consistent with appropriate liquidity and risk objectives. Pursuant to this
policy, the Company may invest in federal, state and municipal obligations,
federal agency obligations, public housing authority bonds, industrial
development revenue bonds, Federal National Mortgage Association ("FNMA"),
Government National Mortgage Association ("GNMA"), and Student Loan Marketing
Association ("SLMA") securities. Additionally, during 2001 the Company's board
of directors approved limited investments in corporate bonds (see below). Except
for corporate bonds, the Company's investments must be rated at least BAA by
Moody's or BBB by Standard and Poor's. Securities rated below A are periodically
reviewed for creditworthiness. The Company may purchase non-rated municipal
bonds only if such bonds are in the Company's general market area and determined
by the Company to have a credit risk no greater than the minimum ratings
referred to above. Industrial development authority bonds, which normally are
not rated, are purchased only if they are judged to possess a high degree of
credit soundness to assure reasonably prompt sale at a fair value. In 2001, the
Company's board of directors authorized the Company to invest a portion of its
security portfolio in high quality corporate bonds, with the amount of bonds
related to any one issuer not to exceed the Company's legal lending limit. Prior
to purchasing a corporate bond, the Company's management performs due diligence
on the issuer of the bond, and the purchase is not made unless the Company
believes that the purchase of the bond bears no more risk to the Company than
would an unsecured loan to the same company.
The Company's investment officers implement the investment policy, monitor
the investment portfolio, recommend portfolio strategies, and report to the
Company's investment committee. Reports of all purchases, sales, issuer calls,
net profits or losses and market appreciation or depreciation of the bond
portfolio are reviewed by the Company's board of directors each month. Once a
quarter, the Company's interest rate risk exposure is monitored by the board of
directors. Once a year, the written investment policy is reviewed by the board
of directors and the Company's portfolio is compared with the portfolios of
other companies of comparable size.
Mergers and Acquisitions
As part of its operations, the Company has pursued an acquisition strategy
over the years to augment its internal growth and regularly evaluates the
potential acquisition of, or merger with, and holds discussions with, various
financial institutions. The Company's acquisitions to date have generally fallen
into one of three categories - 1) an acquisition of a financial institution or
branch thereof within a market the Company operates, 2) an acquisition of a
financial institution or branch thereof in a market contiguous to which the
Company operates, or 3) an acquisition of a company that has products or
services that the Company does not currently offer.
The Company believes that by pursuing these types of acquisition
opportunities the Company can enhance its earnings by any combination or all of
the following: 1) achieving cost efficiencies, 2) enhancing the acquiree's
earnings or gaining new customers by introducing a more successful banking model
with more products and services to the acquiree's market base, 3) increasing
customer satisfaction or gaining new customers by providing more locations for
the convenience of customers, and 4) leveraging the Company's customer base by
offering new products and services.
In the last three years, the Company has made acquisitions in all three of
the aforementioned categories of acquisitions. In 2002, the Company completed
the acquisition of a branch within its market geography (Broadway, located in
Lee County) with approximately $8.4 million in deposits and $3.1 million in
loans. In 2001, acquisitions resulted in the Company adding $116.2 million in
loans and $204.6 million in deposits, expansion into three contiguous markets
(Lumberton, Pembroke, St. Pauls), provided another branch for customers in one
of the Company's newer markets (Salisbury), and gave the Company the ability to
offer property and casualty insurance coverage. In addition, the Company had two
acquisitions pending completion at
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December 31, 2002 (both of which were completed in January 2003), one of which
is the acquisition of a financial institution in a market contiguous to a
current market, and the other is the acquisition of a property and casualty
insurance agency located in Montgomery County. The Company plans to continue to
evaluate acquisition opportunities that could potentially benefit the Company.
This may include acquisitions that do not fit the categories discussed above.
For a further discussion of recent acquisition activity, see "Merger and
Acquisition Activity" under Item 7 - Management's Discussion and Analysis.
Employees
As of December 31, 2002, the Company had 409 full-time and 75 part-time
employees. The Company is not a party to any collective bargaining agreements
and considers its employee relations to be good.
Supervision and Regulation
As a bank holding company, the Company is subject to supervision,
examination and regulation by the Board of Governors of the Federal Reserve
System and the North Carolina Office of the Commissioner of Banks. The Bank is
subject to supervision and examination by the Federal Deposit Insurance
Corporation and the North Carolina Office of the Commissioner of Banks. See also
Note 15 to the consolidated financial statements.
Supervision and Regulation of the Company
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
required to register as such with the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board" or "FRB"). The Company is also regulated by
the North Carolina Office of the Commissioner of Banks (the "Commissioner")
under the Bank Holding Company Act of 1984.
A bank holding company is required to file quarterly reports and other
information regarding its business operations and those of its subsidiaries with
the Federal Reserve Board. It is also subject to examination by the Federal
Reserve Board and is required to obtain Federal Reserve Board approval prior to
making certain acquisitions of other institutions or voting securities. The
Commissioner is empowered to regulate certain acquisitions of North Carolina
banks and bank holding companies, issue cease and desist orders for violations
of North Carolina banking laws, and promulgate rules necessary to effectuate the
purposes of the Bank Holding Company Act of 1984.
Regulatory authorities have cease and desist powers over bank holding
companies and their nonbank subsidiaries where their actions would constitute a
serious threat to the safety, soundness or stability of a subsidiary bank. Those
authorities may compel holding companies to invest additional capital into
banking subsidiaries upon acquisition or in the event of significant loan losses
or rapid growth of loans or deposits.
In 1999, the U.S. enacted legislation that allowed bank holding companies
to engage in a wider range of non-banking activities, including greater
authority to engage in securities and insurance activities. Under the
Gramm-Leach-Bliley Act (the "Act"), a bank holding company that elects to become
a financial holding company may engage in any activity that the Federal Reserve
Board, in consultation with the Secretary of the Treasury, determines by
regulation or order is (i) financial in nature, (ii) incidental to any such
financial activity, or (iii) complementary to any such financial activity and
does not pose a substantial risk to the safety or soundness of depository
institutions or the financial system generally. This Act made significant
changes in U.S. banking law, principally by repealing certain restrictive
provisions of the 1933 Glass-Steagall Act. The Act specifies certain activities
that are deemed to be financial in nature, including lending, exchanging,
transferring, investing for others, or safeguarding money or securities;
underwriting and selling insurance; providing financial, investment, or economic
advisory services; underwriting, dealing in or making a market in, securities;
and any activity currently permitted for bank holding companies by the Federal
Reserve Board under Section 4(c)(8) of the
9
Holding Company Act. The Act does not authorize banks or their affiliates to
engage in commercial activities that are not financial in nature. A bank holding
company may elect to be treated as a financial holding company only if all
depository institution subsidiaries of the holding company are well-capitalized,
well-managed and have at least a satisfactory rating under the Community
Reinvestment Act. At the present time, the Company does not anticipate applying
for status as a financial holding company under the Act.
National and state banks are also authorized by the Act to engage, through
"financial subsidiaries," in any activity that is permissible for a financial
holding company (as described above) and any activity that the Secretary of the
Treasury, in consultation with the Federal Reserve Board, determines is
financial in nature or incidental to any such financial activity, except (i)
insurance underwriting, (ii) real estate development or real estate investment
activities (unless otherwise permitted by law), (iii) insurance company
portfolio investments and (iv) merchant banking. The authority of a national or
state bank to invest in a financial subsidiary is subject to a number of
conditions, including, among other things, requirements that the bank must be
well-managed and well-capitalized (after deducting from the bank's capital
outstanding investments in financial subsidiaries).
The Act also contained a number of other provisions that affected the
Company's operations and the operations of all financial institutions. One of
those provisions related to the financial privacy of consumers and authorized
federal banking regulators to adopt rules that would limit the ability of banks
and other financial entities to disclose non-public information about consumers
to non-affiliated entities. The rules that have subsequently been adopted by the
bank regulators require more disclosure to consumers regarding the privacy of
the information they provide, and in some circumstances, require consent by the
consumer before information is allowed to be provided to a third party. These
rules took effect on July 1, 2001. The Company believes its operations are in
compliance with the rules.
The United States Congress and the North Carolina General Assembly have
periodically considered and adopted legislation that has resulted in, and could
result in further, deregulation of both banks and other financial institutions.
Such legislation could modify or eliminate geographic restrictions on banks and
bank holding companies and current restrictions on the ability of banks to
engage in certain nonbanking activities. For example, the Riegle-Neal Interstate
Banking Act, which was enacted several years ago, allows expansion of interstate
acquisitions by bank holding companies and banks. This and other legislative and
regulatory changes have increased the ability of financial institutions to
expand the scope of their operations, both in terms of services offered and
geographic coverage. Such legislative changes have placed the Company in more
direct competition with other financial institutions, including mutual funds,
securities brokerage firms, insurance companies, investment banking firms, and
internet banks. The Company cannot predict what other legislation might be
enacted or what other regulations might be adopted or, if enacted or adopted,
the effect thereof on the Company's business.
Supervision and Regulation of the Bank
Federal banking regulations applicable to all depository financial
institutions, among other things, (i) provide federal bank regulatory agencies
with powers to prevent unsafe and unsound banking practices; (ii) restrict
preferential loans by banks to "insiders" of banks; (iii) require banks to keep
information on loans to major shareholders and executive officers; and (iv) bar
certain director and officer interlocks between financial institutions.
As a state chartered bank, the Bank is subject to the provisions of the
North Carolina banking statutes and to regulation by the Commissioner. The
Commissioner has a wide range of regulatory authority over the activities and
operations of the Bank, and the Commissioner's staff conducts periodic
examinations of banks and their affiliates to ensure compliance with state
banking regulations. Among other things, the Commissioner regulates the merger
and consolidation of state-chartered banks, the payment of dividends, loans to
officers and directors, recordkeeping, types and amounts of loans and
investments, and the establishment of branches. The Commissioner also has cease
and desist powers over state-chartered banks for violations of state banking
laws or
10
regulations and for unsafe or unsound conduct that is likely to jeopardize the
interest of depositors.
The dividends that may be paid by the Bank to the Company are subject to
legal limitations under North Carolina law. In addition, regulatory authorities
may restrict dividends that may be paid by the Bank or the Company's other
subsidiaries. The ability of the Company to pay dividends to its shareholders is
largely dependent on the dividends paid to the Company by its subsidiaries.
The Bank is a member of the Federal Deposit Insurance Corporation (the
"FDIC"), which currently insures the deposits of member banks. For this
protection, each bank pays a quarterly statutory assessment, based on its level
of deposits, and is subject to the rules and regulations of the FDIC. The FDIC
also is authorized to approve conversions, mergers, consolidations and
assumptions of deposit liability transactions between insured banks and
uninsured banks or institutions, and to prevent capital or surplus diminution in
such transactions where the resulting, continuing, or assumed bank is an insured
nonmember bank. In addition, the FDIC monitors the Bank's compliance with
several banking statutes, such as the Depository Institution Management
Interlocks Act and the Community Reinvestment Act of 1977. The FDIC also
conducts periodic examinations of the Bank to assess its compliance with banking
laws and regulations, and it has the power to implement changes in or
restrictions on a bank's operations if it finds that a violation is occurring or
is threatened.
Neither the Company nor the Bank can predict what other legislation might
be enacted or what other regulations might be adopted, or if enacted or adopted,
the effect thereof on the Bank's operations.
See "Capital Resources and Shareholders' Equity" under Item 7 -
Management's Discussion and Analysis below for a discussion of regulatory
capital requirements.
Available Information
The Company maintains a corporate Internet site at www.firstbancorp.com.
This website is in the process of being substantially upgraded, and significant
enhancements of the site are expected in the near future. The Company has not
made its filings with the Securities and Exchange Commission available on its
website because of limitations within its current website, but such filings are
available from the Securities and Exchange Commission website at www.sec.gov or
free of charge upon written request to the Company's corporate secretary at the
Company's headquarters address. In connection with improvements to the Company's
Internet website that are currently in process, the Company expects to begin
making its periodic filings with the Securities and Exchange Commission
available on the Company's website in the near future.
Item 2. Properties
The main offices of the Company, the Bank and First Bancorp Financial are
located in a three-story building in the central business district of Troy,
North Carolina. The building houses administrative, training and bank teller
facilities. The Bank's Operations Division, including customer accounting
functions, offices and operations of Montgomery Data, and offices for loan
operations, are housed in a one-story steel frame building approximately
one-half mile west of the main office. The Company operates 48 bank branches and
facilities. The Company owns all its bank branch premises except ten branch
offices for which the land and buildings are leased and three branch offices for
which the land is leased but the building is owned. There are no other options
to purchase or lease additional properties. The Company considers its facilities
adequate to meet current needs.
Item 3. Legal Proceedings
Various legal proceedings may arise in the ordinary course of business and
may be pending or threatened against the Company and/or its subsidiaries. The
Company is not involved in any pending legal proceedings that management
believes could have a material effect on the consolidated financial position of
the Company.
11
Item 4. Submission of Matters to a Vote of Shareholders
No matters were submitted to a vote of shareholders during the fourth
quarter of 2002.
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters
The Company's common stock trades on the NASDAQ National Market System of
the NASDAQ Stock Market under the symbol FBNC. Tables 1 and 22, included in
"Management's Discussion and Analysis" below, set forth the high and low market
prices of the Company's common stock as traded by the brokerage firms that
maintain a market in the Company's common stock and the dividends declared for
the periods indicated. All amounts prior to the Company's September 2000
acquisition of First Savings, except for the Company's stock price, have been
restated to include the combined results of First Bancorp and First Savings. See
"Business - Supervision and Regulation" and Note 15 to the consolidated
financial statements for a discussion of regulatory restrictions on the payment
of dividends. As of January 31, 2003, there were approximately 2,300
shareholders of record and another 2,300 shareholders whose stock is held in
"street name."
Item 6. Selected Financial Data
Table 1 on page 43 sets forth selected consolidated financial data for the
Company.
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Management's discussion and analysis is intended to assist readers in
understanding the Company's results of operations and changes in financial
position for the past three years. This review should be read in conjunction
with the consolidated financial statements and accompanying notes beginning on
page 55 of this report and the supplemental financial data contained in Tables 1
through 22 included with this discussion and analysis.
CRITICAL ACCOUNTING POLICIES
Due to the estimation process and the potential materiality of the amounts
involved, the Company has identified the accounting for the allowance for loan
losses and the related provision for loan losses as an accounting policy
critical to the Company's financial statements. The provision for loan losses
charged to operations is an amount sufficient to bring the allowance for loan
losses to an estimated balance considered adequate to absorb probable losses
inherent in the portfolio.
Management's determination of the adequacy of the allowance is based
primarily on a mathematical model that estimates the appropriate allowance for
loan losses. This model has two components. The first component involves the
estimation of losses on loans defined as "impaired loans." A loan is considered
to be impaired when, based on current information and events, it is probable the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The estimated valuation allowance is the
difference, if any, between the loan balance outstanding and the value of the
impaired loan as determined by either 1) an estimate of the cash flows that the
Company expects to receive from the borrower discounted at the loan's effective
rate, or 2) in the case of a collateral-dependent loan, the fair value of the
collateral.
The second component of the allowance model is to estimate losses for all
loans not considered to be impaired loans. First, loans that have been risk
graded by the Company as having more than "standard" risk but are not considered
to be impaired are assigned estimated loss percentages generally accepted in the
banking industry. Loans that are classified by the Company as having normal
credit risk are segregated by loan type, and estimated loss percentages are
assigned to each loan type, based on the historical losses, current economic
conditions, and
12
operational conditions specific to each loan type.
The reserve estimated for impaired loans is then added to the reserve
estimated for all other loans. This becomes the Company's "allocated allowance."
In addition to the allocated allowance derived from the model, management also
evaluates other data such as the ratio of the allowance for loan losses to total
loans, net loan growth information, nonperforming asset levels and trends in
such data. Based on this additional analysis, the Company may determine that an
additional amount of allowance for loan losses is necessary to reserve for
probable losses. This additional amount, if any, is the Company's "unallocated
allowance." The sum of the allocated allowance and the unallocated allowance is
compared to the actual allowance for loan losses recorded on the books of the
Company and any adjustment necessary for the recorded allowance to equal the
computed allowance is recorded as a provision for loan losses.
While management uses the best information available to make evaluations,
future adjustments may be necessary if economic, operational, or other
conditions change. In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Company's allowance for
loan losses. Such agencies may require the Company to recognize adjustments to
the allowance based on the examiners' judgment about information available to
them at the time of their examinations.
For further discussion including a review of the range of provisions for
loan losses and its impact on reported results in recent periods, see
"Nonperforming Assets" and "Allowance for Loan Losses and Loan Loss Experience"
under "Analysis of Financial Condition and Changes in Financial Condition."
DISCUSSION REGARDING IMPACT OF ACCOUNTING METHODS USED IN MERGERS AND
ACQUISITIONS
While merger and acquisition activity was relatively insignificant in
2002, the years ended December 31, 2001 and 2000 were both significantly
impacted by merger and acquisition activity, as discussed below. The merger and
acquisition activities for each year were recorded using different methods of
accounting. The different methods of accounting impacted the financial
information presented in this Form 10-K in different ways.
As previously noted, in 2000 the Company completed the merger-acquisition
of First Savings Bancorp, Inc, which just prior to the merger date had total
assets equaling 52% of the Company's total assets and had 43% more shareholders'
equity than the Company. Because this merger was accounted for under
pooling-of-interests accounting, the financial reporting rules required that the
Company restate all historical financial results by retroactively combining the
past results that each company achieved separately and presenting them as the
Company's historical financial results - as if the two companies had always
operated together. Therefore, except in specifically noted circumstances, there
is no incremental impact to the Company's financial information presented herein
that can be discerned as a result of the acquisition of First Savings.
The Company's one acquisition in 2002 and all four acquisitions in 2001
(see discussion below) were accounted for using the purchase method of
accounting. The purchase method of accounting requires that the assets and
liabilities acquired be reflected as part of the Company's assets and
liabilities as of the date of the acquisition. Therefore, the incremental impact
of each of the acquisitions since 2000 is more evident.
Other significant differences in pooling-of-interests accounting and
purchase accounting relate to the treatment of certain merger expenses and the
method of recording the assets and liabilities of the acquired entity, as
discussed in the following two paragraphs.
In accordance with pooling-of-interests accounting, all merger costs (e.g.
attorney fees, investment banker fees, accounting fees, employment contract
payments) related to the First Savings acquisition were recognized as expense in
the income statement. Conversely, purchase accounting requires that the direct
costs related to a
13
merger be treated as part of the purchase price of the acquisition, and
therefore all such direct merger costs were effectively capitalized and
increased the amount of goodwill recorded in each purchase transaction.
In accordance with pooling-of-interests accounting, the Company recorded
the acquisition of First Savings using the historical cost basis for all of
First Savings' assets and liabilities. The excess of the assets over liabilities
recorded (i.e. First Savings shareholders' equity) was added to the
shareholders' equity of the Company. The value of the stock that the Company
issued as merger consideration was not considered in the accounting entries, and
therefore under pooling-of-interests accounting, no intangible assets were
recognized. Under the purchase accounting method used for the Company's 2001 and
2002 acquisitions, the Company valued all assets and liabilities of the acquired
entities at their fair market value. Because for each of the Company's 2001 and
2002 acquisitions, the value of the consideration paid exceeded the net fair
market value of its assets less its liabilities, intangible assets were recorded
for the differences between the two.
MERGER AND ACQUISITION ACTIVITY
Over the past three fiscal years, the Company has completed several
acquisitions and had one branch divestiture. Significant amounts of intangible
assets have been recorded in connection with the Company's acquisitions, as
detailed below. The accounting for intangible assets changed significantly in
2002 with the Company being required under new accounting standards to cease the
amortization of virtually all of its intangible assets. See the section entitled
"Current Accounting Matters" below and Note 2 and Note 6 to the consolidated
financial statements for additional information regarding intangible assets and
their amortization under previous and new accounting standards.
The Company completed one acquisition in 2002 as follows:
(a) Broadway branch purchase - On October 4, 2002, the Company completed
the purchase of a branch of RBC Centura located in Broadway, North Carolina. The
Company assumed the branch's $8 million in deposits and $3 million in loans. The
primary reason for this acquisition was to increase the Company's presence in
Lee County, a market that the Company already had two branches in with a large
customer base. An intangible asset of $0.7 million, all of which was allocated
to goodwill, was recorded in connection with this acquisition.
The Company's acquisitions completed during 2001 were as follows:
(a) Salisbury branch purchase - On December 17, 2001, the Company
completed the purchase of a branch of First Union National Bank located in
Salisbury, North Carolina. The Company assumed the branch's $30 million in
deposits and $9 million in loans. An intangible asset of $3.2 million was
recorded in connection with this acquisition.
(b) Insurance agency acquisitions - On May 30, 2001, the Company completed
the purchase of two insurance agencies - Aberdeen Insurance & Realty Company and
Hobbs Insurance and Realty Company. Both agencies were located in Moore County
and specialized in placing property and casualty insurance coverage for
individuals and businesses in the Moore County area. In completing the
acquisition, the agencies were merged into First Bank Insurance Services, Inc.
Approximately 16,000 shares of Company stock were issued in connection with the
acquisition of the two agencies. An intangible asset of $243,000 was recorded in
connection with the acquisition.
(c) Century Bancorp, Inc. - On May 17, 2001, the Company completed the
purchase of Century Bancorp, Inc. ("Century"). Century was the holding Company
for Home Savings, Inc., SSB, a one branch savings institution located in
Thomasville, NC. Century had total assets of $107 million, total loans of $90
million, and total deposits of $72 million. In accordance with the terms of the
merger agreement, the Company issued approximately 586,000 shares of common
stock and paid cash of approximately $13.2 million to Century shareholders in
exchange for all shares of Century outstanding. An intangible asset of $3.2
million was recorded
14
in connection with this acquisition.
(d) Robeson and Scotland counties branch purchase - On March 26, 2001, the
Company completed the purchase of four branches from First Union National Bank
with aggregate deposits of approximately $103 million and aggregate loans of
approximately $17 million. The four branches acquired were in Lumberton,
Pembroke, St. Pauls (all located in Robeson County, NC), and Laurinburg
(Scotland County, NC). Total intangible assets of $14.6 million were recorded in
connection with the purchase.
As discussed above, each of the above transactions was accounted for using
the purchase method of accounting. The following table presents a summary of the
fair market value of assets acquired and liabilities assumed in the purchases
described above:
Robeson and
Salisbury Insurance Scotland
Assets acquired branch agencies Century counties branches Total
- --------------- ------ -------- ------- ----------------- -----
(in millions)
Cash $17.7 -- 5.9 70.2 93.8
Securities -- -- 9.0 -- 9.0
Loans, gross 9.3 -- 90.2 16.7 116.2
Allowance for loan losses (0.2) -- (0.6) (0.3) (1.1)
Premises and equipment 0.5 0.1 0.6 1.9 3.1
Other -- -- 1.4 -- 1.4
----- ----- ----- ----- -----
Total assets acquired 27.3 0.1 106.5 88.5 222.4
----- ----- ----- ----- -----
Liabilities assumed
Deposits 30.3 -- 71.7 102.6 204.6
Borrowings -- -- 13.5 -- 13.5
Other 0.2 -- 2.5 0.5 3.2
----- ----- ----- ----- -----
Total liabilities assumed 30.5 -- 87.7 103.1 221.3
----- ----- ----- ----- -----
Value of cash paid and/or
stock issued to stock-
holders of acquiree n/a 0.3 22.0 n/a 22.3
----- ----- ----- ----- -----
Intangible assets recorded $ 3.2 0.2 3.2 14.6 21.2
===== ===== ===== ===== =====
There are many factors that the Company considers when evaluating how much
to offer for potential acquisition candidates - in the form of a purchase price
comprised of cash and/or stock for a whole company purchase or a deposit premium
in a branch purchase. Most significantly, the Company compares expectations of
future earnings per share on a stand-alone basis with projected future earnings
per share assuming completion of the acquisition under various pricing
scenarios. Significant assumptions that affect this analysis include the
estimated future earnings stream of the acquisition candidate, the amount of
cost efficiencies that can be realized, and the interest rate earned/lost on the
cash received/paid. In addition to the earnings per share comparison, the
Company also considers other factors including (but not limited to): marketplace
acquisition statistics, location of the candidate in relation to the Company's
expansion strategy, market growth potential, management of the candidate,
potential integration issues (including corporate culture), and the size of the
acquisition candidate.
The generally higher amounts of intangible assets recorded relative to
assets and deposits acquired in the branch purchases shown above compared to the
Century acquisition are primarily a result of the branches having a higher
relative earnings stream, due largely to having a higher mix of
transaction-oriented deposit accounts that carried low interest rates and high
potential for service charge income.
The lone acquisition during 2000 was the September 14, 2000 merger
acquisition of First Savings Bancorp, Inc. - the holding company for First
Savings Bank of Moore County, SSB (collectively referred to as "First Savings").
Each share of First Savings stock was exchanged for 1.2468 shares of the
Company's stock, resulting in the Company issuing approximately 4,407,000 shares
of stock to complete the transaction. At June 30, 2000, First Savings had total
assets of $331 million, with loans of $232 million and deposits of $224 million.
15
To gain Federal Reserve approval for the merger with First Savings, the
Company was required to divest the First Savings Bank branch located in
Carthage, NC. This branch was sold to another North Carolina community bank in a
transaction that was completed in November 2000. At the time of the divestiture,
the Carthage branch had approximately $15.1 million in total deposits and $2.3
million in total loans. The sale of the branch resulted in a net gain of
$808,000.
The Company had two pending acquisitions as of December 31, 2002, as
follows:
(a) Uwharrie Insurance Group - On October 7, 2002, the Company announced
that its insurance subsidiary, First Bank Insurance, had reached an agreement to
acquire Uwharrie Insurance Group, a Montgomery County based property and
casualty insurance agency. With eight employees, Uwharrie Insurance Group, Inc.
serves approximately 5,000 customers, primarily from its Troy-based
headquarters, and has annual commissions of approximately $500,000. The primary
reason for the acquisition was to gain efficiencies of scale with the Company's
existing property and casualty insurance business. The transaction was completed
on January 2, 2003, with the Company paying cash in the amount of $546,000. The
tangible assets of Uwharrie Insurance Group on the date of acquisition were
approximately $20,000, which resulted in the Company recording an intangible
asset of approximately $526,000. The Company is currently in the process of
determining what portion of the intangible asset will be allocated to
identifiable intangible assets and what portion will be allocated as goodwill.
(b) On July 16, 2002, the Company reported that it had agreed to acquire
Carolina Community Bancshares, Inc. (CCB), a South Carolina community bank with
total assets of approximately $70 million. CCB operates out of three branches in
Dillon County, South Carolina, with its headquarters and one of its branches
located in Latta, and two branches in the city of Dillon. This represents the
Company's first entry into South Carolina. Dillon County, South Carolina is
contiguous to Robeson County, North Carolina, a county where the Company
operates four branches. The terms of the agreement called for shareholders of
Carolina Community to receive 0.8 shares of First Bancorp stock and $20.00 in
cash for each share of Carolina Community stock they owned. The transaction was
completed on January 15, 2003 with the Company paying cash of $8.3 million,
issuing 332,888 shares of common stock valued at approximately $7.9 million, and
assuming employee stock options with an intrinsic value of approximately $0.9
million, for a total deal value of approximately $17.1 million. The following is
a condensed unaudited balance sheet, as reported by CCB, as of the acquisition
date of January 15, 2003.
CCB
-------------
Assets (in millions)
------
Cash and cash equivalents $ 7.0
Securities 13.0
Loans, gross 47.7
Allowance for loan losses (0.8)
Premises and equipment 0.8
Intangible assets 0.8
Other 1.7
-----
Total assets $70.2
=====
Liabilities
-----------
Deposits $58.7
Borrowings 2.0
Other 0.7
-----
Total liabilities 61.4
-----
Shareholders' equity 8.8
-----
Total liabilities and shareholders' equity $70.2
=====
16
ANALYSIS OF RESULTS OF OPERATIONS
Net interest income, the "spread" between earnings on interest-earning
assets and the interest paid on interest-bearing liabilities, constitutes the
largest source of the Company's earnings. Other factors that significantly
affect operating results are the provision for loan losses, noninterest income
such as service fees and noninterest expenses such as salaries, occupancy
expense, equipment expense and other overhead costs, as well as the effects of
income taxes.
Note Regarding Pro Forma Information
In an effort to enhance the comparability of the core operating results of
the Company between years, the Company has presented certain pro forma financial
data in "Table 1 - Selected Consolidated Financial Data" and at various times in
the discussion below will refer to pro forma data. In Table 1, the pro forma
data is presented as adjustments to reported earnings, with the resulting pro
forma diluted earnings per share shown. Performance ratios have not been
adjusted to reflect the effects of the pro forma data.
Two types of pro forma adjustments have been made. The first adjustment
identifies the net after-tax effects of unusual or nonrecurring gains or losses.
Examples of these types of items are merger expenses, securities gains/losses,
fixed asset gains/losses, and foreclosed property gains/losses. These types of
gains or losses occur at irregular intervals and are not considered by the
Company to be an indication of the core operating results of the Company. To
eliminate the effects of these nonrecurring items, net gains are deducted from
reported income and net losses are added to reported income.
In the past five years, only net income for the year 2000 included
nonrecurring income or expense that impacted net income by more than 2%. The
results of operations for the year 2000 were significantly impacted by the
Company's merger-acquisition of First Savings. In connection with this
acquisition, there were several material nonrecurring items of income and
expense related to the transaction, as follows:
o $3,188,000 in expenses ($2,593,000 after-tax) that were incurred in
completing the merger. These expenses consisted primarily of
investment banker fees, attorney fees, employment contract payments,
accountant fees, and early termination fees associated with vendor
contracts. These expenses were all recorded in the third quarter of
2000.
o $2,006,000 in losses ($1,218,000 after-tax) from sales of
securities. The merger with First Savings increased the Company's
liability sensitive position. To reduce the Company's interest rate
risk exposure, approximately $54.5 million in securities were sold
at a total loss of $2,006,000. The proceeds from the sale were first
used to repay short-term debt, with the remaining proceeds invested
in investments with a shorter average life and a higher yield than
the securities sold.
o $420,000 was recorded ($254,000 after-tax) as a one time adjustment
to the allowance for loan losses during the third quarter of 2000.
This provision for loan losses was recorded in order to align the
credit risk methodologies of the Company and First Savings.
o $808,000 was realized as a gain ($491,000 after-tax) from the sale
of the Company's Carthage branch during the fourth quarter of 2000.
The sale of this branch was a regulatory requirement for approval of
the merger with First Savings.
17
The following table presents a summary of items for each of the past three
years that the Company considers to be nonrecurring in nature. The "Impact on
Net Income" and "Impact on Diluted Earnings Per Share" columns reflect the
after-tax amount of the pro forma data at the blended federal and state tax
rate.
($ in thousands, except per share data) Gross Amount Impact on Impact on Diluted
Income/(Expense) Net Income Earnings Per Share
---------------- ---------- ------------------
2002
----------------------------------------------------
Items affecting noninterest income
----------------------------------------------------
Individually insignificant amounts of
securities gains, loan sale gains, and
other, net $ 22 14 --
======= ======= =======
2001
----------------------------------------------------
Items affecting noninterest income
----------------------------------------------------
Loan sale gains $ 9 6 --
Securities gains, net 61 40 --
Other gains 79 51 0.01
------- ------- -------
Total impact on 2001 $ 149 97 0.01
======= ======= =======
2000
----------------------------------------------------
Merger-related addition to provision for loan losses
$ (420) (254) (0.03)
------- ------- -------
Items affecting noninterest income
----------------------------------------------------
Securities losses - merger-related (2,006) (1,218) (0.14)
Other securities gains, net 87 53 0.01
Branch sale gain 808 491 0.05
Other (6) (4) --
------- ------- -------
Impact on 2000 noninterest income (1,117) (678) (0.08)
------- ------- -------
Items affecting noninterest expense
----------------------------------------------------
Merger-related expenses (3,188) (2,593) (0.28)
------- ------- -------
Impact on 2000 noninterest expense (3,188) (2,593) (0.28)
------- ------- -------
Total impact on 2000 $(4,725) (3,525) (0.39)
======= ======= =======
The second pro forma adjustment, shown in the following table, relates to
two new accounting standards adopted by the Company in 2002 related to
accounting for mergers and acquisitions - Financial Accounting Standards Board
Statement No. 142 entitled "Goodwill and Other Intangible Assets" and No. 147
entitled "Acquisitions of Certain Financial Institutions." Under these
standards, as of January 1, 2002, the Company was required to cease the
systematic amortization (as expense) of virtually all of its intangible assets.
The elimination of this type of expense for 2002 but not for previous years (as
required by the standards) affects the comparability of the Company's financial
results between 2002 and all previous years. To enhance comparability, in Table
1 for years prior to 2002, the after-tax effect of the amortization of
intangible assets that were no longer amortized beginning in 2002 is shown as a
positive adjustment to adjust the Company's net income for each year to reflect
what it would have been had the new accounting standards been applicable to
previous years.
The following table presents gross amortization expense for each of the
past three years, along with the amounts of amortization expense related to
intangible assets that ceased to be amortized beginning on January 1, 2002. The
table also includes the after-tax effects on net income and diluted earnings per
share associated with this amortization expense that represents the additional
amounts the Company would have reported had the amortization provisions of
Statements 142 and 147 been applicable in those years.
18
Impact on Diluted
Amortization Earnings Per Share
Expense Related to of Amortization
Intangible Assets Expense Related to
Gross Amortization Expense Related that Ceased to be Intangible Assets
Amortization to Intangible Assets that Amortized on that Ceased to be
Expense Ceased to be Amortized on January 1, 2002, Amortized on
Recorded January 1, 2002 Net of Taxes January 1, 2002
------------ ----------------------------- ------------------ -------------------
($ in thousands, except per share data)
2002 $ 31 -- -- --
2001 1,535 1,510 1,160 0.12
2000 631 610 527 0.06
Overview - 2002 Compared to 2001
Net income for the year ended December 31, 2002 amounted to $17,230,000,
or $1.85 per diluted share, a 25.9% increase in diluted earnings per share over
the $1.47 per diluted share for the year ended December 31, 2001. As noted
above, in 2002, in accordance with the adoption of two new accounting standards,
the Company discontinued the amortization of most of its intangible assets. If
the newly adopted standards had been applicable in 2001, the Company would have
recorded additional net income of $1,160,000, or approximately $0.12 per diluted
share, for the twelve months ended December 31, 2001. Nonrecurring items of
income/expense were insignificant for the year ended December 31, 2002, while
nonrecurring gains of approximately one cent per share were realized for the
twelve months ended December 31, 2001.
Adjusting for the pro forma items discussed in the paragraph above and in
the section entitled "Note Regarding Pro Forma Information" above, the Company's
pro forma net income for 2002 amounted to $17,216,000, a 17.3% increase from pro
forma net income for 2001 of $14,679,000. Pro forma diluted earnings per share
for 2002 remained unchanged from the unadjusted reported amount of $1.85 per
share, 17.1% higher than pro forma diluted earnings per share of $1.58 for 2001.
The most significant factor in the Company's increase in net income from
2001 to 2002 was an $8.3 million, or 20.3%, increase in net interest income. As
discussed in more detail below in the section entitled "Net Interest Income,"
the increase in net interest income was a result of a higher level of average
earning assets and a higher net interest margin. Average earning assets
increased 10.9% in 2002, while the Company's net interest margin (tax-equivalent
net interest income divided by average earning assets) increased from 4.23% in
2001 to 4.58% in 2002.
Partially offsetting the increase in net interest income was a higher
provision for loan losses. Although asset quality ratios generally improved in
2002, the Company's provision for loan losses more than doubled due to high loan
growth, amounting to $2,545,000 in 2002 compared to $1,151,000 in 2001. In 2002,
First Bancorp experienced $105 million in internal loan growth compared to $28
million in 2001.
Noninterest income increased 24.0% and noninterest expense increased 12.8%
in 2002 compared to 2001, primarily as a result of the Company's growth,
including a full year's impact of the acquisitions completed in 2001.
Noninterest income was also positively affected in 2002 by increased mortgage
loan refinancing activity that increased mortgage origination fees, as well as
the offering of a check overdraft product beginning in August 2001 that
increased fees earned on deposit accounts for a full 12 months in 2002.
The increase in noninterest expenses was partially offset by the near
elimination of amortization expense related to intangible assets. As noted above
in the section entitled "Note Regarding Pro Forma Information," in 2002 the
Company adopted two new accounting standards that required the Company to cease
amortization of
19
virtually all of its intangible assets. Excluding amortization expense in 2001
related to intangible assets that ceased to be amortized in 2002, the Company's
noninterest expenses increased 19.1% in 2002.
The Company's income taxes increased 27.0% from $7,307,000 in 2001 to
$9,282,000 in 2002. The increase in income tax expense was a result of higher
income before income taxes. The effective tax rate for both years was
approximately 35%.
Overview - 2001 Compared to 2000
Net income for the year ended December 31, 2001 amounted to $13,616,000, a
45.8% increase from the $9,342,000 recorded for 2000. Diluted earnings per share
for 2001 amounted to $1.47, a 42.7% increase from the $1.03 reported for 2000.
As discussed above, net income for 2000 was significantly impacted by the merger
with First Savings.
Adjusting for the pro forma items discussed above, pro forma net income
for the year ended December 31, 2001 amounted to $14,679,000, a 9.6% increase
from the $13,394,000 in pro forma net income for 2000. Diluted earnings per
share on a pro forma basis for 2001 amounted to $1.58, a 6.8% increase from the
pro forma diluted earnings per share amount of $1.48 for 2000.
The Company's net income and most individual components of net income for
2001 were significantly impacted by the acquisitions completed during the year.
As a result of the 2001 acquisitions, the Company's loans increased by $116.2
million and deposits increased by $204.6 million, whereas internally generated
loan and deposit growth amounted to only $28.1 million and $25.3 million,
respectively. As a result of the incremental impact of these acquired loans and
deposits, net interest income for the year increased 6.1% despite a decrease in
the net interest margin from 4.53% in 2000 to 4.23% in 2001.
The provision for loan losses for 2001 amounted to $1,151,000, which is
comparable to the recurring provision for loan losses of $1,185,000 recorded in
2000 (the 2000 amount excludes the one time $420,000 acquisition related
provision previously discussed). The slightly lower provision in 2001 compared
to the recurring 2000 provision was a result of lower net internal loan growth
in 2001. In 2001, the Company's net internal loan growth amounted to $28.1
million compared to $102.9 million in 2000. An increase in nonperforming assets
during 2001 increased what otherwise would have been an even lower level of
provision for loan losses in 2001.
The incremental impact of the 2001 acquisitions also contributed
significantly to the 104.2% increase in noninterest income (62.6% increase on a
pro forma basis when nonrecurring gains/losses are excluded) and the 7.1%
increase in noninterest expenses from the amounts recorded in 2000 (18.2%
increase on a pro forma basis). Also increasing noninterest income in 2001 were
increased fees earned from presold mortgages, which benefited from a lower
interest rate environment, and the introduction of a deposit product in August
2001 which, for a fee, allows checking account customers to overdraw their
deposit account.
The Company's income taxes increased 27.4% from $5,736,000 in 2000 to
$7,307,000 in 2001. The increase in income tax expense was a result of higher
income before income taxes. The effective tax rate for 2001 of 34.9% was lower
than the 38.0% effective tax rate in 2000, primarily due to nondeductible
merger-related expenses incurred in 2000 that had the effect of increasing the
effective tax rate.
Net Interest Income
Net interest income on a reported basis amounted to $49,390,000 in 2002,
$41,053,000 in 2001, and $38,695,000 in 2000. For internal purposes and in the
discussion that follows, the Company evaluates its net interest income on a
tax-equivalent basis by adding the tax benefit realized from tax-exempt
securities to reported interest income. Net interest income on a
taxable-equivalent basis amounted to $49,925,000 in 2002, $41,645,000 in 2001,
and $39,289,000 in 2000.
20
Table 2 analyzes net interest income on a taxable-equivalent basis. The
Company's net interest income on a taxable-equivalent basis increased by 19.9%
in 2002 and 6.0% in 2001. There are two primary factors that cause changes in
the amount of net interest income recorded by the Company - 1) growth in loans
and deposits, and 2) the Company's net interest margin (tax-equivalent net
interest income divided by average interest-earning assets).
In both 2002 and 2001, net interest income was positively impacted by
higher amounts of average loans and deposits outstanding. Table 3 illustrates
that the change in the average volume of loans and deposits was the predominant
factor in the higher amounts of net interest income realized by the Company in
2002 and 2001. In 2002, the average amount of loans outstanding grew by 14.8%,
while the average amount of deposits increased by 12.3%. In 2001, the average
amount of loans outstanding increased 18.6% and the average amount of deposits
outstanding increased 20.8%. The higher amounts of loans and deposits
outstanding in 2001 and 2002 were a result of both internal growth, as well as
growth achieved in corporate acquisitions. In 2001, most of the loan and deposit
growth was achieved in acquisitions, with 81% of the year's $144 million in loan
growth and 89% of the year's $230 million deposit growth coming by way of
acquisition. In 2002, the increase in the average amount of loans and deposits
outstanding was partially a result of a full year's effect of the 2001 growth as
well as growth realized in 2002, most all of which was internally generated. In
2002, loans grew by $108 million, with all but $3 million of the growth
internally generated, while deposits grew by $56 million, with all but $8
million internally generated.
The effects on net interest income of the higher amounts of average loans
and deposits outstanding in 2002 were enhanced by a higher net interest margin
in 2002 compared to 2001. The Company's net interest margin for 2002 was 4.58%
compared to 4.23% in 2001. The 4.23% net interest margin for 2001 was a decrease
from the 4.53% margin realized in 2000. The variations in net interest margin
over the past two years have been largely a result of the Federal Reserve's
interest rate policies during that time.
In 2001, the Company's interest rate spreads were negatively impacted by
the Federal Reserve Board cutting interest rates 11 times totaling 475 basis
points. Although at January 1, 2001 the Company had more interest-sensitive
liabilities than interest-sensitive assets subject to repricing within twelve
months, the Company's interest-sensitive assets repriced sooner (generally the
day following the interest rate cut) and by a larger percentage (generally by
the same number of basis points that the Federal Reserve discount rate was
decreased) than did the Company's interest-sensitive liabilities that were
subject to repricing. The Company's primary interest-sensitive liabilities at
January 1, 2001 in the twelve month horizon consisted of the following 1)
savings, NOW, and money market deposits, and 2) time deposits. Interest rates
paid on savings, NOW and money market deposits are set by management of the
Company, and although the interest rates on these accounts were decreased by the
Company within days of each of the Federal Reserve rate cuts, it was not
possible to reduce the interest rates by the full amount of the Federal Reserve
cuts due to competitive considerations and the already relatively low rates paid
on these types of accounts. Interest rates paid on time deposits are generally
fixed and not subject to automatic adjustment. When time deposits mature, the
Company has the opportunity, at the customers' discretion, to renew the time
deposit at a rate set by the Company. Because time deposits that are
interest-sensitive in a twelve month horizon mature throughout the twelve month
period, any change in the renewal rate will only affect a portion of the twelve
month period. Also, although changes in interest rates on renewing time deposits
generally track rate changes in the interest rate environment, the Company was
not able to decrease rates on renewing time deposits during 2001 by the
corresponding decreases in the Federal Reserve discount rate because of
competitive pressures in the Company's market.
In 2002, there were no changes to interest rates initiated by the Federal
Reserve for the first ten months of the year. This allowed a significant portion
of the Company's time deposit portfolio that had been originated when rates were
higher to mature and reprice at lower rates - as noted above, much of the
Company's interest-sensitive assets had repriced immediately in 2001 when the
rate cuts were made and did not experience further declines. The 50 basis point
rate cut announced by the Federal Reserve on November 6, 2002 negatively
impacted the Company's net interest margin in much the same way as the 2001 rate
cuts did. The Company's fourth quarter of
21
2002 net interest margin decreased to 4.53% from the 4.78% margin realized in
the third quarter of 2002.
Another factor affecting the Company's net interest margin in 2001 and
2002 was the reinvestment of funds received in the Company's 2001 acquisitions
and the mix of loans and deposits assumed in the acquisitions. The March 2001
acquisition of four branches from First Union National Bank resulted in the
Company receiving $70.2 million in cash. The Company was not able to immediately
redeploy the cash received into a mix of higher yielding investments and loans
consistent with the Company's historic asset mix, and therefore the Company's
net interest margin was negatively impacted. In 2002, due to the high loan
growth experienced by the Company, a significant portion of this cash was
redeployed into loans with higher interest rates than the short-term investments
in which the cash had been invested. Additionally, in connection with the
acquisition of Century in May 2001, the Company assumed a high mix of
residential mortgage loans and time deposits (which are generally the lowest
yielding type of loan and highest rate type of deposit). This mix of loans and
deposits negatively impacted net interest margins in 2001. In 2002, many of
Century's loans were refinanced by the borrower and then resold in the secondary
market by the Company, with the resulting funds used to fund the Company's
commercial loan growth (which generally has higher interest rates than
residential mortgages). In addition, many of Century's time deposits also had
the opportunity to reprice at lower rates in 2002, thus positively impacting the
net interest margin.
See additional information regarding net interest income on page 36 in the
section entitled "Interest Rate Risk."
Provision for Loan Losses
The provision for loan losses charged to operations is an amount
sufficient to bring the allowance for loan losses to an estimated balance
considered appropriate to absorb probable losses inherent in the portfolio.
Management's determination of the adequacy of the allowance is based on the
level of loan growth, an evaluation of the portfolio, current economic
conditions, historical loan loss experience and other risk factors.
The Company recorded provisions for loan losses of $2,545,000 in 2002
compared to $1,151,000 in 2001 and $1,605,000 in 2000.
The increase in the provision for loan losses for 2002 compared to 2001
was primarily a result of higher internal loan growth, as asset quality ratios
generally improved during the year. In 2002, the Company generated $105.2
million in internal loan growth compared to $28.1 million in internal growth in
2001. The remainder of the $3.1 million in loan growth in 2002 and $116.2
million in loan growth in 2001 came by way of acquisitions with a preexisting
allocation for loan losses already in place.
The decrease in the provision for loan losses in 2001 compared to 2000 was
impacted by the Company's merger with First Savings. As noted earlier, in
connection with the merger with First Savings, a provision of $420,000 was
recorded in 2000 in order to align the risk methodologies of the two merging
companies. Excluding the merger-related 2000 provision, the Company's 2001
provision for loan losses was approximately 3% less than the recurring 2000
provision of $1,185,000. The decrease in the recurring provision for loan losses
was a result of significantly lower loan growth experienced. Net internal loan
growth (excludes loans assumed in acquisitions) for 2001 amounted to $28.1
million compared to $102.9 million for 2000. An increase in nonperforming assets
and net charge-offs during 2001 increased what would have been an otherwise
lower level of provision for loan losses in 2001.
See the section entitled "Allowance for Loan Losses and Loan Loss
Experience" below for a more detailed discussion of the allowance for loan
losses. The allowance is monitored and analyzed regularly in conjunction with
the Company's loan analysis and grading program, and adjustments are made to
maintain an adequate allowance for loan losses.
22
Noninterest Income
Noninterest income recorded by the Company amounted to $11,968,000 in
2002, $9,655,000 in 2001, and $4,729,000 in 2000.
Noninterest income for 2000 was significantly impacted by losses incurred
from sales of securities that were partially offset by a gain realized from the
sale of a branch. Both the securities losses and the branch sale gain were
related to the merger acquisition of First Savings - see additional discussion
below. As shown in Table 4, core noninterest income, which excludes gains and
losses from sales of securities, loans, and other assets, as well as
nonrecurrring items, amounted to $11,946,000 in 2002 a 25.7% increase from the
$9,506,000 in 2001. The 2001 core noninterest income of $9,506,000 was 62.6%
higher than the $5,846,000 recorded in 2000.
See Table 4 and the following discussion for an understanding of the
components of noninterest income.
Service charges on deposit accounts in 2002 amounted to $6,856,000, a
30.2% increase compared to the $5,265,000 recorded in 2001. The 2001 amount of
$5,265,000 was 68.9% higher than the 2000 amount of $3,118,000. In addition to
incremental service fee income associated with the Company's internally
generated deposit growth and periodic deposit rate fee increases, there have
been two primary factors driving the high growth in service charges - 1) the
acquisition of five First Union branches during 2001 - four bank branches were
acquired in March 2001 and one branch was acquired in December 2001. These
branches had a high level of transaction accounts (non-time deposits), $83.4
million in total, which afforded the Company the opportunity to earn deposit
service charges, and 2) the introduction of a product in August 2001 that
charges a fee for allowing customers to overdraw their deposit account. This
product has generated approximately $125,000 in fees per month (net of related
expenses) since its introduction.
Other service charges, commissions and fees amounted to $2,336,000 in
2002, a 14.2% increase from the $2,046,000 earned in 2001. The 2001 amount of
$2,046,000 was 17.6% higher than the $1,740,000 recorded in 2000. This category
of noninterest income includes items such as safety deposit box rentals, fees
from sales of personalized checks, check cashing fees, credit card and merchant
income, debit card income, and ATM charges. This category of income grew
primarily because of increases in these activity-related fee services as a
result of overall growth in the Company's total customer base, including growth
achieved from corporate acquisitions.
Fees from presold mortgages amounted to $1,713,000 in 2002, a 36.1%
increase from the 2001 amount of $1,259,000. The 2001 amount was a 178% increase
from the $453,000 recorded in 2000. The increases in the past two years have
been primarily attributable to two factors - 1) a higher level of mortgage loan
refinancings caused by the progressively lower interest rate environments, and
2) the decision by the Company in late 2000 to sell a higher percentage of
single family home loan originations into the secondary market as opposed to
holding them in the Company's loan portfolio. This strategy was implemented in
an effort to shift the Company's loan portfolio to having a higher percentage of
commercial loans, which are generally shorter term in nature and have higher
interest rates.
Commissions from sales of insurance and financial products amounted to
$738,000 in 2002, $731,000 in 2001, and $418,000 in 2000. This line item
includes commissions the Company receives from three sources - 1) sales of
credit insurance associated with new loans, 2) commissions from the sales of
investment, annuity, and long-term care insurance products, and 3) commissions
from the sale of property and casualty insurance. The following table presents
the contribution of each of the three sources to the total amount recognized in
this line item:
23
($ in thousands) 2002 2001 2000
Commissions earned from: ---- ---- ----
------------------------
Sales of credit insurance $326 389 306
Sales of investments, annuities,
and long term care insurance 210 227 112
Sales of property and casualty
insurance 202 115 --
---- ---- ----
Total $738 731 418
==== ==== ====
The variance in the commissions from sales of credit insurance has been
primarily due to fluctuations in the annual profit sharing bonus that the
Company received from the insurance carriers for which the Company acts as a
broker. Commissions from sales of investments, annuities, and long term care
insurance increased throughout 2000 and 2001 after its late 1999 introduction
and decreased slightly in 2002 as a result of a lower amount of investment
transactions, possibly due to the declining stock market. Commissions from the
sale of property and casualty insurance have increased since the May 2001
completion of the purchase of two insurance companies that specialize in such
insurance. Property and casualty insurance commissions are expected to further
increase beginning in the first quarter of 2003 as a result of the pending
acquisition of Uwharrie Insurance Group, which was completed on January 2, 2003.
See the section above entitled "Merger and Acquisition Activity" for additional
discussion.
Data processing fees amounted to $303,000 in 2002, $205,000 in 2001, and
$117,000 in 2000. As noted earlier, Montgomery Data makes its excess data
processing capabilities available to area financial institutions for a fee.
These fees have increased as a result of an increase in data processing clients
from two clients to four clients in the past three years, as well as an increase
in the size and number of transactions generated by those clients.
Noninterest income not defined as "core" amounted to a net gain of $22,000
in 2002, a net gain of $149,000 in 2001, and a net loss of $1,117,000 in 2000.
The 2002 net gain of $22,000 primarily related to miscellaneous securities gains
of $25,000. The 2001 net gain of $149,000 primarily relates to a $79,000 gain
from the sale of two buildings that the Company previously operated as branches
that were consolidated with other branches in the same towns, and securities
that were sold at a $61,000 gain. The net losses of $1,117,0000 recorded in 2000
primarily related to two merger-related events - a $2,006,000 loss resulting
from a third quarter 2000 restructuring of the combined investment portfolio to
reduce the Company's liability sensitive position and an $808,000 gain realized
from the fourth quarter sale of a branch that was required to be divested in
order to gain regulatory approval.
Noninterest Expenses
Noninterest expenses for 2002 were $32,301,000, compared to $28,634,000 in
2001 and $26,741,000 in 2000. Table 5 presents the components of the Company's
noninterest expense during the past three years.
Based on the recorded amounts noted above, noninterest expenses increased
12.8% in 2002 and 7.1% in 2001. Those growth rates were impacted by two factors,
both of which served to reduce the year to year percentage increases. First, as
noted earlier, amortization expense was significantly lower in 2002 than in
previous years as a result of adopting two new accounting standards in 2002 that
resulted in the Company ceasing to record amortization expense related to nearly
all of its intangible assets as of January 1, 2002. Second, the Company recorded
$3,188,000 in merger expenses in the third quarter of 2000. These expenses
consisted primarily of investment banker fees, attorney fees, employment
contract payments, accountant fees, and early termination fees associated with
vendor contracts. Adjusting the reported amounts in 2001 and 2000 to exclude
amortization expense related to intangible assets that ceased to be amortized
beginning on January 1, 2002 and excluding merger expenses recorded in 2000, the
increases in noninterest expenses were 19.1% in 2002 and 18.2% in 2001 over the
prior year amounts.
24
The increases in noninterest expenses over the past two years have
occurred in nearly every line item of expense and have been primarily as a
result of the significant growth experienced by the Company. Over the past two
years, the number of the Company's branches has increased from 40 to 48, and the
number of full time/part time employees has increased from 306/55 at December
31, 2000 to 409/75 at December 31, 2002. Additionally, from December 31, 2000 to
December 31, 2002, the amount of loans outstanding has increased 34% and
deposits have increased 37%.
Income Taxes
The provision for income taxes was $9,282,000 in 2002, $7,307,000 in 2001,
and $5,736,000 in 2000. The 27.0% increase in income tax expense in 2002
compared to 2001 was a result of a 26.7% increase in income before income taxes.
The effective tax rate for each of the years ended December 31, 2002 and 2001
was approximately 35%.
The 27.4% increase in income tax expense in 2001 compared to 2000 was a
result of a 38.8% increase in pretax income, which was partially offset by a
lower effective tax rate - 34.9% in 2001 compared to 38.0% in 2000. The lower
effective tax rate in 2001 was due to the 2000 effective tax rate being inflated
because of the nondeductibility for tax purposes of certain merger expenses.
Table 6 presents the components of tax expense and the related effective
tax rates.
ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION
Overview
Over the past two years the Company has achieved high increases in its
levels of loans and deposits. In 2002, most of the increase was internally
generated whereas in 2001, this growth was primarily related to corporate
acquisitions. The following table presents information regarding the nature of
the Company's growth in 2002 and 2001:
Balance at Balance at Total Percentage growth,
(in thousands) beginning Internal Growth from end of percentage excluding
of period growth acquisitions period growth acquisitions
---------- ---------- ------------ ---------- ---------- ------------------
2002
- -----------------------------
Loans $ 890,310 105,154 3,083 998,547 12.2% 11.8%
========== ========== ========== ========== ====== ======
Deposits - Noninterest bearing 96,065 14,665 1,650 112,380 17.0% 15.3%
Deposits - Savings, NOW, and
Money Market 353,439 30,930 3,322 387,691 9.7% 8.8%
Deposits - Time>$100,000 189,948 9,846 -- 199,794 5.2% 5.2%
Deposits - Time<$100,000 360,829 (8,206) 3,469 356,092 -1.3% -2.3%
---------- ---------- ---------- ---------- ------ ------
Total deposits $1,000,281 47,235 8,441 1,055,957 5.6% 4.7%
========== ========== ========== ========== ====== ======
2001
- -----------------------------
Loans $ 746,089 28,058 116,163 890,310 19.3% 3.8%
========== ========== ========== ========== ====== ======
Deposits - Noninterest bearing $ 70,634 2,978 22,453 96,065 36.0% 4.2%
Deposits - Savings, NOW, and
Money Market 253,687 18,684 81,068 353,439 39.3% 7.4%
Deposits - Time>$100,000 140,992 19,205 29,751 189,948 34.7% 13.6%
Deposits - Time<$100,000 305,066 (15,601) 71,364 360,829 18.3% -5.1%
---------- ---------- ---------- ---------- ------ ------
Total deposits $ 770,379 25,266 204,636 1,000,281 29.8% 3.3%
========== ========== ========== ========== ====== ======
25
As noted above, in 2002 the Company's growth was primarily internally
generated and loan growth more than doubled deposit growth. Most of the
Company's internal loan growth occurred in the first half of the year ($79
million of the $105 million in total internal growth) as the Company experienced
strong growth in several of the markets it had entered in 2001. In the second
half of the year, loan growth slowed due to the Company having met the initial
credit demand in the new markets it had entered, and due to the continued
effects of the recessionary economy. New loan originations throughout the year
were partially offset by a large volume of loan customers that refinanced their
home loans with the Company, which the Company subsequently sold into the
secondary market instead of maintaining in the Company's loan portfolio. As
noted above in the section entitled "Noninterest Income," in late 2000, the
Company decided to sell a higher percentage of single family home loan
originations into the secondary market as opposed to holding them in the
Company's loan portfolio. This strategy was implemented in an effort to shift
the Company's loan portfolio to having a higher percentage of commercial loans,
which are generally shorter term in nature and have higher interest rates.
In the first half of 2002, the Company's deposit growth continued the low
internal growth rates experienced in recent years, with just $2 million in net
deposit growth. However, internal deposit growth increased significantly in the
second half of 2002, amounting to $45 million, which the Company believes was
partially due to investors taking their money out of the chronically declining
stock market and depositing it into FDIC insured bank deposits.
In 2001, the Company's corporate acquisitions were the primary reason for
the increases in loans and deposits. Internal loan growth was substantially
matched by a similar rate of internal deposit growth. The rates of internal
growth were less than 5% for each. The Company believes the relatively low loan
demand and deposit growth in 2001 were a result of the recessionary economy and
the lower interest rates paid on deposits as a result of the declining interest
rate environment.
The higher loan growth experienced in 2002 compared to deposit growth
resulted in a reduction of the Company's liquidity. The Company's liquidity had
improved significantly in 2001 as a result of receiving $81 million in net cash
in connection with the 2001 acquisitions. These funds served as the primary
source of funding needs in 2002.
The Company issued $20 million in trust preferred securities in 2002,
which qualify as Tier I capital. As a result, the Company's capital ratios
improved in 2002 after declining in 2001 as a result of the acquisitions
completed during the year. All three regulatory capital ratios have
significantly exceeded the minimum regulatory thresholds for all periods covered
by this report.
The Company's asset quality ratios generally improved in 2002 and remain
favorable compared to peers. In 2001, the Company's asset quality ratios
declined slightly as a result of the generally recessionary economy that caused
an increase in delinquencies and bankruptcies, as well as one large credit that
was placed on nonaccrual status in the first quarter of 2001.
In the years leading up to 2001, the Company's market area, the central
Piedmont region of North Carolina, had a healthy economy, with low unemployment
and a low business failure rate. During 2001, the economy in this area, as well
as the rest of the nation, slowed. In the second half of 2001, there were
announcements of corporate bankruptcies, layoffs and plant closings in the
Company's market area. While the economy in the Company's market area remained
recessionary in 2002, it did not significantly worsen from 2001, and the
Company's credit losses remained stable during the year.
The Company does not participate in large syndicated credits that have
resulted in large credit losses at several other North Carolina-based banks.
26
Distribution of Assets and Liabilities
Table 7 sets forth the percentage relationships of significant components
of the Company's balance sheets at December 31, 2002, 2001, and 2000.
The most significant variance in the percentages from 2001 to 2002 is the
relative percentage of loans to total assets - this amount increased from 77% at
December 31, 2001 to 81% at December 31, 2002. The increase in this percentage
primarily reflects the high loan growth experienced by the Company in 2002 of
$108.2 million, which outpaced deposit growth of $55.7 million. The funding for
this loan growth primarily came from maturities of securities available for
sale, which decreased by three percentage points as a percent of total assets
during 2002. Within deposit categories, there was a slight shift from time
deposits to demand deposits and savings, NOW, and money market deposits. The
Company believes this may be due to customers deciding that it is advantageous
to have their funds in more liquid investments due to the relatively small
difference in rates paid on non-time deposits compared to the rates paid on time
deposits in today's interest rate environment.
The variances in the percentages from 2001 to 2000 reflect the effects of
the Company's acquisitions during 2001, as internal growth, as noted above, did
not materially impact the Company's balance sheet. The total growth in deposits
of $229.9 million exceeded the $144.2 million in total loan growth, which
resulted in net loans to total assets decreasing from 81% at year end 2000 to
77% at year end 2001, and deposits to total assets increasing from 84% to 88%
over the same period. The Company assumed $80.6 million in net cash related to
the 2001 acquisitions which was not fully reinvested in securities or loans,
resulting in the percentage of short-term investments to total assets increasing
from 1% to 6%. A slight decrease in the dollar amount of total securities
outstanding, coupled with the significant increase in the Company's total
assets, had the effect of reducing the percentage of total securities to total
assets from 13% at December 31, 2000 to 9% at December 31, 2001.
Securities
Information regarding the Company's securities portfolio as of December
31, 2002, 2001, and 2000 is presented in Tables 8 and 9.
The composition of the investment securities portfolio reflects the
Company's investment strategy of maintaining an appropriate level of liquidity
while providing a relatively stable source of income. The investment portfolio
also provides a balance to interest rate risk and credit risk in other
categories of the balance sheet while providing a vehicle for the investment of
available funds, furnishing liquidity, and supplying securities to pledge as
required collateral for certain deposits.
Total securities available for sale and held to maturity amounted to $80.8
million, $112.8 million, and $117.5 million at December 31, 2002, 2001, and
2000, respectively. The decrease in securities from December 31, 2001 to
December 31, 2002 was primarily attributable to called and maturing bonds, as
well as a high level of principal repayments on mortgage-backed securities due
to the low interest rate environment. Instead of reinvesting the
maturities/paydowns back into securities, the proceeds were used to fund the
high loan growth experienced. In comparing December 31, 2001 to December 31,
2000, although the total amount of the Company's securities did not change
materially, upon the adoption of Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities," the Company
transferred on January 1, 2001, as permitted by the standard upon its adoption,
held-to-maturity securities with an amortized cost of approximately $31.7
million to the available-for-sale category at fair value.
From 2000 to 2001, the primary variance in the mix of the securities
portfolio was a shift from U.S. Government agency debt to mortgage-backed
securities and corporate bonds. Obligations of U.S. Government agencies as a
percentage of total securities decreased from 45% at December 31, 2000 to 25% at
December 31, 2001, while mortgage-backed securities increased from 31% at
December 31, 2000 to 46% at December 31, 2001
27
and corporate bonds increased from 0% to 8% of total securities over that same
one year period. During 2001, in an effort to enhance yield, while at the same
time managing interest rate exposure, the Company invested more heavily in
mortgage-backed securities and corporate bonds than U.S. Government agencies. In
2002, the change in the mix of securities was primarily due to variances in the
receipt of maturities/paydowns of the various categories of investments, as the
Company purchased very few securities as a result of the proceeds of the
maturities/paydowns being used to fund loan growth.
The majority of the Company's U.S. Government agency debt securities are
issued by the Federal Home Loan Bank and carry one maturity date, often with an
issuer call feature, while the mortgage-backed securities have been primarily
issued by Freddie Mac and Fannie Mae and vary in their repayment in correlation
with the underlying pools of home mortgage loans. The Company's investment in
corporate bonds is primarily comprised of trust preferred securities issued by
other North Carolina bank holding companies.
Included in mortgage-backed securities at December 31, 2002 were
collateralized mortgage obligations (CMO's) with an amortized cost of
$12,590,000 and a fair value of $12,720,000. Included in mortgage-backed
securities at December 31, 2001 were CMO's with an amortized cost of $21,703,000
and a fair value of $21,886,000. Included in mortgage-backed securities at
December 31, 2000 were CMO's with an amortized cost of $13,543,000 and a fair
value of $13,521,000. The CMO's that the Company has invested in are
substantially all "early tranche" pieces of the CMO, which minimizes the
prepayment risk to the Company.
At December 31, 2002, net unrealized gains of $1,399,000 were included in
the carrying value of securities classified as available for sale, compared to a
net unrealized gain of $1,024,000 at December 31, 2001 and a net unrealized gain
of $383,000 at December 31, 2000. The increase in the unrealized gain position
at each of the past two year ends is a result of the progressively lower
interest rate environment in effect at each period end. Management evaluated any
unrealized losses on individual securities at each year end and determined them
to be of a temporary nature and caused by fluctuations in market interest rates,
not by concerns about the ability of the issuers to meet their obligations. Net
unrealized gains, net of applicable deferred income taxes, of $853,000,
$677,000, and $256,000 have been reported as part of a separate component of
shareholders' equity (accumulated other comprehensive income) as of December 31,
2002, 2001, and 2000, respectively.
The fair value of securities held to maturity, which the Company carries
at amortized cost, was more than the carrying value at