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SECURITIES AND EXCHANGE COMMISSION
UNITED STATES
Washington, D.C. 20549
FORM 10-K
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Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended:
December 31, 2004
Commission File Number: 000-13086
FNB FINANCIAL SERVICES CORPORATION
(Exact name of Registrant as specified in its Charter)
North Carolina 56-1382275
(State of Incorporation) (I.R.S. Employer Identification No.)
1501 Highwoods Blvd., Suite 400
Greensboro, North Carolina 27410
(Address of principal executive offices) (Zip Code)
(336) 369-0900
(Registrant's telephone number, including area code)
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Securities Registered Pursuant to Section 12(g) of the Securities Exchange Act
of 1934:
Name of each exchange
Title of each class on which registered
------------------- ---------------------
Common Stock, $1.00 par value Nasdaq Stock Market
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K contained herein, and none will be contained, to the best of
Registrant's knowledge, in definitive proxy or information statements
incorporated by references in Part III of this Form 10-K or any amendment to
this Form 10-K.|X|
Check whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. YES |X| NO |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES |X| NO |_|
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant, based on the average bid and asked price of
the Common Stock on the last business day of the Registrant's most recently
completed second fiscal quarter, was approximately $92.7 million. As of March
14, 2005 (the most recent practicable date), the Registrant had outstanding
5,578,895 shares of Common Stock.
Portions of the Proxy Statement of the Registrant for the Annual Meeting of
Shareholders to be held on May 19, 2005, are incorporated by reference in Part
III of this report.
The Exhibit Index begins on page 77.
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FNB Financial Services Corporation
Form 10-K
Table of Contents
Index Page
- ----- ----
PART I
Item 1. Business .............................................................. 4
Item 2. Properties ............................................................ 17
Item 3. Legal Proceedings ..................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders ................... 17
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities .......................... 18
Item 6. Selected Financial Data ............................................... 19
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations ................... 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ............ 41
Item 8. Financial Statements and Supplementary Data ........................... 45
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ............................. 72
Item 9A. Controls and Procedures ............................................... 72
Item 9B. Other Information ..................................................... 72
PART III
Item 10. Directors and Executive Officers of the Registrant .................... 73
Item 11. Executive Compensation ................................................ 73
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters ........................................ 73
Item 13. Certain Relationships and Related Transactions ........................ 73
Item 14. Principal Accountant Fees and Services ................................ 74
PART IV
Item 15. Exhibits and Financial Statement Schedules ............................ 74
Signatures ............................................................ 76
Statement Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains and incorporates by reference
statements relating to future results of FNB Financial Services Corporation (the
"Company" ) that are considered "forward-looking" within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21B of the Securities
Exchange Act of 1934, as amended (the "Exchange Act" ). The forward-looking
statements are principally, but not exclusively, contained in Item 1: "Business"
and Item 7: "Management's Discussion and Analysis of Financial Condition and
Results of Operations." These statements relate to, among other things,
expectations concerning loan demand, growth and performance, simulated changes
in interest rates and the adequacy of our allowance for loan losses. These
statements involve known and unknown risks, uncertainties and other factors that
may cause our actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements. Actual results may differ materially
from those expressed or implied as a result of certain risks and uncertainties,
including, but not limited to, changes in political and economic conditions,
interest rate fluctuations, competitive product and pricing pressures within our
markets, equity and fixed income market fluctuations, personal and corporate
customers' bankruptcies, inflation, acquisitions and integrations of acquired
businesses, technological changes, changes in law and regulations, changes in
fiscal, monetary, regulatory and tax policies, monetary fluctuations, success in
gaining regulatory approvals when required, as well as, other risks and
uncertainties reported from time to time in our filings with the Securities and
Exchange Commission (the "SEC" ). Forward-looking statements and factors that
may cause actual results to differ materially are also discussed at the
beginning of Item 7: "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Broadly speaking, forward-looking
statements include:
o projections of the Company's revenues, income, earnings per share,
capital expenditures, dividends, capital structure or other
financial items;
o descriptions of plans or objectives of the Company's management for
future operations, products or services;
o forecasts of the Company's future economic performance; and
o descriptions of assumptions underlying or relating to any of the
foregoing.
The Company may make forward-looking statements discussing management's
expectations about:
o future credit losses and nonperforming assets;
o the impact of new accounting standards;
o future short-term and long-term interest rate levels and their
impact on the Company's net interest margin, net income, liquidity
and capital; and
o future capital expenditures.
Forward-looking statements discuss matters that are not historical facts.
Because they discuss future events or conditions, forward-looking statements
often include words such as "anticipate," "might," "believe," "estimate,"
"expect," "plan," "could," "may," "should," "will," "would," or similar
expressions. Do not unduly rely on forward-looking statements. They detail
management's expectations about the future and are not guarantees.
Forward-looking statements speak only as of the date they are made, and
management may not update them to reflect changes that occur after the date the
statements are made.
PART I
Item 1. Business
General
FNB Financial Services Corporation (the "Company") is a North Carolina ("NC")
financial holding company with consolidated assets of $865.3 million, deposits
of $724.3 million and shareholders' equity of $70.4 million, as of December 31,
2004. The Company was organized in 1984 as a North Carolina bank holding
company, although its predecessor and wholly-owned subsidiary, FNB Southeast
(the "Bank"), opened as Rockingham Savings Bank and Trust in 1910, and was then
chartered as a national bank in 1918 under the name of First National Bank of
Reidsville. In May 1997, the Bank changed its name to First National Bank
Southeast to reflect its expansion into new markets. Effective March 15, 1999,
the Bank changed its charter from a national bank to a NC state bank and changed
its name to FNB Southeast. The Company filed an election with the Federal
Reserve Board to become a financial holding company on January 23, 2001, and
became a financial holding company effective February 12, 2001, under the
Gramm-Leach-Bliley Act. A financial holding company is permitted to engage in
activities that are financial in nature or incidental to a financial activity.
The permitted activities of a financial holding company are broader than for a
bank holding company.
Historically, the Company has served the Rockingham County area of NC through
three branches in Reidsville and two in Eden, NC. In 1995, the Company initiated
a new strategic growth plan. On August 31, 1999, the Company acquired Black
Diamond Savings Bank, FSB ("Black Diamond"), a federal savings bank
headquartered in Norton, Virginia ("VA"). By the end of 2004, the Bank's
branching network included offices in the Rockingham County towns of Eden,
Ruffin and Madison and in the new markets of Greensboro, Burgaw and Wilmington
and the number of North Carolina branches had grown from five to thirteen. It
also completed the acquisition of the Harrisonburg, VA branch of Guaranty Bank.
The acquisition of Black Diamond also added branches in Norton, Harrisonburg,
Pennington Gap and Richlands, VA. The Bank of Tazewell purchased selected loans
and assumed the deposits of the Bank's Richlands, VA branch during April 2004.
The Bank transferred $15.0 million in deposit accounts and $7.3 million in loan
accounts in the transaction. The Company recognized approximately $700,000 in
net gain on the sale. Also during April, an approximate $125,000 gain was
realized from the sale of the fixed assets associated with the Bank's Richlands,
VA branch. The Company also relocated its headquarters during the second quarter
of 2004 to Greensboro, NC.
The Bank is community oriented and focuses primarily on offering commercial,
real estate and consumer loans, and deposit and other financial services to
individuals, small to medium-sized businesses and other organizations in its
market areas. It emphasizes individualized services and community involvement,
while at the same time providing its customers with the financial sophistication
and array of products typically offered by larger banks. It competes
successfully with larger banks located within and outside NC and VA by retaining
its personalized approach and community focus.
Under the leadership of Ernest J. Sewell, who became President and Chief
Executive Officer in 1995, the Company adopted the following three-part
strategy: (1) increase market share and geographic reach through opportunistic
acquisitions in markets where the mix of economic, operational, cultural and
other factors are favorable; (2) position the Company to manage its planned
growth by adding experienced personnel and upgrading its internal systems and
procedures; and (3) generate internal growth at its existing banking offices by
offering new and complementary services and products. To accomplish these
objectives, during the past ten years the Company has: (a) increased the number
of its NC banking offices to thirteen; (b) expanded the number of its full-time
personnel by adding new employees, including several senior executives; (c)
completed the merger with Black Diamond to extend the Company's reach into
selected VA markets; (d) completed a systematic review and revision of its loan
administration, loan
4
policy and credit procedures; (e) enhanced its mix of products and services by
forming investment services and mortgage banking subsidiaries; (f) relocated its
corporate headquarters to Greensboro, NC.; and (g) moved forward with its
leadership transition strategy by promoting Pressley A. Ridgill to President of
the Bank. Ridgill joined the Company in 2000 as Executive Vice President and
Chief Operating Officer of the Bank and during his five years with the Company
has directed the operations and planning of numerous areas within the Bank,
including Finance, Deposit Operations, Information Technology, Risk Management,
and Investor Relations. As President, he will continue to manage the investment
portfolio, assist with the strategic direction of the organization, and evaluate
and negotiate acquisitions.
The Company plans to continue to pursue its strategy by strengthening its
presence in existing markets and opportunistically reaching into new markets in
NC and VA. The Company continues to seek qualified personnel to help manage its
planned growth and to develop new products that are consistent with the
Company's customer service orientation. For example, the Company opened a
wholesale mortgage division in the fourth quarter of 2003 and staffed the
division with twelve employees. During 2004, and at the outset of 2005, the
Company also added several members to its management team in light of its
continued growth and to reflect the steps underway to continue its overall
strategy.
Paul McCombie, C. Grayson Whitt and Alan D. Pike joined the Bank as senior vice
presidents and regional executives. McCombie assumed responsibility for our
coastal offices located in Wilmington and Burgaw. Whitt will manage the Bank's
full-service offices in Rockingham County, NC, while Pike will oversee the
banking offices in Guilford County. Kenneth W. Banner joined the Bank as
Executive Vice President of FNB Southeast Mortgage Corporation and will be
responsible for all aspects of the mortgage banking operation. Thomas M. Saitta
joined the Bank in the newly created position of Director of Marketing to
support its expanding sales and marketing efforts.
During 2004, the Company (i) installed a new mainframe computer and related
software, (ii) redesigned commercial and retail products, (iii) expanded online
banking services, and (iv) announced the renovation of the Company's Operations
Center in Reidsville, NC. The Company also plans, where appropriate, to continue
to upgrade its systems and procedures and refine its ability to offer customers
sophisticated services without sacrificing its personalized approach.
Strategy
Expand Banking Operations. Throughout most of its 95-year history, the Company's
banking activities were centered around Reidsville, located in Rockingham County
in the north central part of NC. Beginning in 1995, however, the Company
initiated a growth strategy to further penetrate markets in which it had an
existing market share and expand into and develop new markets, such as
Wilmington and Greensboro in NC and into VA. Management selects its target
markets based on a number of factors, including market size and growth
potential, banking relationships developed by members of management during their
careers and the ability to integrate the targeted market into the Company's
community oriented culture.
The Company's expansion strategy, both within and outside of its existing
markets, involves three key elements: (i) ascertaining which markets may be
underserved by financial institutions whose primary focus is to cater to the
individualized needs of the customer; (ii) installing high-quality, well-trained
management to serve the market; and (iii) locating reasonably priced facilities.
Management believes that it has been successful in implementing these strategic
elements in its expansion program to date.
The Guilford County deposit market is the largest in the Company's market area
and totaled $6.71 billion at June 30, 2004. In April 2004, the Company completed
the relocation of its headquarters to 1501 Highwoods Boulevard, Greensboro. The
Company is the largest financial holding company headquarted in Greensboro, NC.
This move will allow the Company more access to the financial markets and assist
5
the Company in reaching the larger customer base in Guilford County. We continue
to evaluate potential sites for additional branches in Guilford and New Hanover
counties in NC and in Rockingham County, VA.
Seize Market Expansion Opportunities. The Company intends to continue to
capitalize on opportunities to enter new and contiguous markets which it
believes are underserved as a result of banking consolidation and in which the
Company's community oriented philosophy and culture might flourish. The Company
believes that there is value to be added by providing the opportunity for
greater personalized banking relationships that exist with larger commercial
banks in its markets, although the Company also recognizes the need to carefully
analyze markets that are already well served by numerous institutions. The
Company will continue to distinguish itself by emphasizing high quality,
sophisticated services in a hometown environment.
Establish a Platform for Future Growth. The Company seeks to position itself to
manage its expected growth in two fundamental ways: (1) attract, retain and
reward experienced personnel who are committed both to conducting business in a
friendly and personable manner and to serving the communities in which they work
and live; and (2) continue to upgrade, modify and expand its internal systems,
procedures, equipment and software to improve operating efficiencies. The
Company will continue to analyze technological developments in the banking
industry for opportunities to improve or augment its services and products;
however, management will continue to make every effort to maintain the Company's
personalized approach.
Maintain a Friendly Environment for Employees and Customers. The Company has
instituted various programs to instill high morale among its employees, which
the Company believes translate into exceptional customer service. The Company
holds weekly sales meetings to elicit ideas about featured products and services
and to develop and communicate ideas for expanding banking relationships with
existing and potential customers. Management believes that the overall effect of
these type programs is to improve morale, customer service and financial
performance. During the second half of 2004, the Company initiated a program to
develop a team concept at the senior management level. Weekly teleconferences
were held to encourage open and direct communication between members of senior
management and provide regular updates on significant activities within their
respective areas. Periodic off site strategic planning sessions of the senior
management team provide an open forum to address concerns and develop
initiatives for the continued improvement of the Company.
6
Market Areas
For operational purposes, the Company groups its markets into four regions: the
Triad and Wilmington regions of NC, and the Norton and Harrisonburg regions of
VA. The Company's deposit market share in the Rockingham County portion of the
Triad Region as of June 30, 2004, the most recent date for which data are
available, was 27.1%, which ranked first among banks and thrift institutions.
The following table summarizes the banking offices and deposit totals for the
Company's offices, categorized by city.
Region and City Deposits at December 31,
-------------------------------------
2004 2003 2002
--------- -------------- ---------
(In thousands)
Triad Region:
Reidsville (1) ........... $ 174,132 $ 196,292 $ 226,819
Eden (2) ................. 52,935 53,322 45,333
Madison .................. 20,984 20,383 22,482
Ruffin ................... 12,256 10,710 10,872
Greensboro (1) ........... 135,964 97,736 77,548
--------- --------- ---------
Subtotal .............. 396,271 378,443 383,054
--------- --------- ---------
Wilmington Region:
Wilmington (2) ........... 122,330 83,668 55,259
Burgaw ................... 32,094 26,954 25,247
--------- --------- ---------
Subtotal .............. 154,424 110,622 80,506
--------- --------- ---------
Norton Region:
Norton ................... 60,801 53,970 58,551
Pennington Gap ........... 19,735 17,973 22,933
Richlands (4) ............ -- 18,641 22,174
--------- --------- ---------
Subtotal .............. 80,536 90,584 103,658
--------- --------- ---------
Harrisonburg Region:
Harrisonburg (3) ......... 93,054 62,258 37,787
--------- --------- ---------
Total deposits ........ $ 724,285 $ 641,907 $ 605,005
========= ========= =========
- ----------
(1) Includes three banking offices for all years.
(2) Includes two banking offices for all years.
(3) Includes two banking office for 2003 and 2004, and one office for 2002.
(4) Branch sold April 2004.
The following is a summary description of the Company's market areas.
Triad Region - Rockingham County. Rockingham County is located in the north
central area of NC. It has a land area of 565 square miles and a population of
approximately 90,000. The Commonwealth of VA borders the County on the north,
while Guilford County is the neighboring county to the south. Piedmont Triad
International Airport is located twenty miles away, and Norfolk Southern has two
rail connection lines in the County. U.S. Highways 29, 158, and 220 serve the
area. The County, which consists of several community oriented towns, provides a
full range of municipal services and extends financial support to certain
boards, agencies, and commissions to assist its effort to serve its citizens.
The North Carolina Employment Security Commission reported a December 2004
unemployment rate of 8.3% for Rockingham County. Business and government leaders
in the county have made progress in diversifying the area's economy to make up
for job losses primarily in the textile and tobacco industries.
Triad Region - Guilford County. Guilford County has a diverse economy
attributable to a blend of trade, manufacturing and service businesses. Local
industry is characterized by the production of a wide range of products,
including textiles, apparel, furniture, tobacco, machinery, pharmaceuticals,
microchips, and
7
electronics equipment. Guilford County, with a population of 420,000, has access
to major domestic and international markets from Interstate Highways 40 and 85;
U.S. Highways 29, 70, 220 and 421; major rail connections; and the Piedmont
Triad International Airport. According to the NC Employment Security Commission,
Guilford County reported an unemployment rate of 4.8% for December 2004,
compared to a statewide unemployment rate of 5.0%. The planned FedEx hub is on
schedule for completion in 2009 and is expected to have a significant positive
impact on the Triad Region of NC. During 2004, Dell announced plans to locate a
major assembly plant in the Triad, which will bring up to 1,500 jobs to the
region. Additionally, Dell suppliers and other complementary businesses are
expected to contribute positively to the economy of the Triad Region.
Wilmington Region. Wilmington is the county seat and industrial center of New
Hanover County, located on the southeast coast of NC. The total population of
the County is approximately 160,000. Interstate Highway 40 and U.S. Highways 17
and 74, as well as major rail connections serve the County. This area is
serviced by national and regional airlines through facilities at the New Hanover
International Airport located near Wilmington. The New Hanover County area has
experienced extensive industrial development and service/trade sector growth
over the past twenty years. Industries in the Wilmington region produce fiber
optic cables for the communications industry; aircraft engine parts,
pharmaceuticals, nuclear fuel components and various textile products. The New
Hanover County area economy has become broadly diversified and has developed
into a major resort area, a busy sea port (one of North Carolina's two deep
water ports), a light manufacturing center, chemical manufacturing center and
the distribution hub of southeastern North Carolina. The NC Employment Security
Commission reported a December 2004 unemployment rate of 3.5% for New Hanover
County.
Norton Region. Norton is located in southwestern VA in the midst of the
Appalachian Mountains. The mining, retail and service industries of this region
operate from an abundant natural resource base that includes natural gas, coal,
timber and mineral deposits. The area is served by several U.S. Highways and by
major rail connections. The Bank operates branches in Norton (Wise County) and,
Pennington Gap (Lee County). The Company sold the Richlands, VA branch in 2004.
For December 2004, the VA Employment Commission reported the unemployment rate
in Wise County was 4.0%.
Harrisonburg Region. Rockingham County is centrally located in the Shenandoah
Valley in west central VA. Harrisonburg, the county seat with a population of
40,000, is an important educational, industrial, retail, tourism, commercial,
agricultural and governmental center. Interstate Highway 81, several primary
U.S. highways, the Shenandoah Valley Regional Airport and a major rail
connection serve the area. The Bank operates two branches in Harrisonburg,
serving the counties of Rockingham and Augusta. According to the VA Employment
Commission, the December 2004 unemployment rate for Rockingham County was 2.0%
compared to a statewide unemployment rate of 3.0%.
Deposits
The Company offers a variety of deposit products to individuals and to small and
medium-sized businesses and other organizations through the Bank at interest
rates generally competitive with local market conditions. The accompanying table
sets forth the mix of depository accounts at the Company as a percentage of
total deposits at the dates indicated.
As of December 31,
----------------------
2004 2003 2002
----- ---- ------
Noninterest-bearing demand ..... 10.9% 10.9% 10.2%
Savings, NOW, MMI .............. 26.5 18.5 16.5
Certificates of deposit ........ 62.6 70.6 73.3
----- ----- ------
100.0% 100.0% 100.0%
===== ===== ======
8
The Bank accepts deposits at its 17 banking offices, 15 of which have automated
teller machines("ATMs"). Its memberships in the "STAR", "CIRRUS" and "PLUS"
networks allow customers access to their depository accounts from regional ATM
facilities. It charges competitive fees for the use of its ATM facilities by
those who are not depositors with the Bank. Deposit flows are controlled
primarily through the pricing of such deposits and, to a certain extent, through
promotional activities. Such promotional activities include the Company's
"Legacy Banking" and "Presidential Banking" accounts for deposit relationships
of $25,000 and $75,000, respectively, and the "Freedom 50 Club", which extends
special privileges and sponsors group excursions to sites and performances of
interest to account holders in certain markets over the age of 55. At December
31, 2004, the Bank had $126.5 million in certificates of deposit of $100,000 or
more. The Bank has joined an electronic network that allows it to post interest
rates and attract certificates of deposit nationally. The investors are
generally credit unions or commercial banks and amounts are typically just under
$100,000 to assure FDIC insurance coverage. It also utilizes brokered deposits
to supplement in-market deposit growth. The accompanying table presents the
scheduled maturities of time deposits of $100,000 or more at December 31, 2004.
Scheduled maturity of time deposits of $100,000 or more
-------------------------------------------------------
(In thousands)
Less than three months ................................ $ 43,994
Three through six months .............................. 51,478
Seven through twelve months ........................... 21,437
Over twelve months .................................... 9,563
---------
Total time deposits - $100,000 or more ............. $ 126,472
=========
See also Note 7 in the Notes to Consolidated Financial Statements of this Annual
Report on Form 10-K.
Subsidiaries
In April 2000, the Company established FNB Southeast Investment Services, Inc.
(the "Investment Subsidiary") as a wholly owned subsidiary of the Bank. The
Investment Subsidiary employs three investment advisors who are based in the
Company's largest markets of Greensboro and Wilmington, NC and Harrisonburg, VA
and allocate their time among the Company's branches and are available to
current and potential customers. The advisors offer a complete line of
investment products and services. The Company receives commissions based on the
advisors'sales and benefits (i) by earning additional fee income and (ii) by
attracting potential customers to its branches. The Investment Subsidiary
generated revenues of $507,000 in 2004 and $670,000 in 2003. During 2004, the
decision was made to upgrade our services and product portfolio through an
association with Raymond James. We expect this change to provide better service
and more diverse products to our customers while yielding increased fee income
to the Company.
In June 2001, the Company established FNB Southeast Mortgage Corporation (the
"Mortgage Subsidiary") as a wholly owned subsidiary of the Bank. At inception,
the Mortgage Subsidiary purchased selected assets of a successful mortgage
brokerage company operating in the coastal area near Wilmington, NC. The Company
formed a wholesale division of the Mortgage Subsidiary during the fourth quarter
of 2003 as part of a continuing strategy to promote the subsidiary's growth and
expand the variety of mortgage services offered. Fee income generated by the
Mortgage Subsidiary increased to $2,233,000 in 2004, compared to $2,019,000 in
2003.
Marketing
The Company currently markets its services through advertising campaigns and in
printed material, such as newspapers, magazines, billboards, and direct
mailings, as well as through promotional items, such as caps, pens, pencils and
shirts. The Company's officers are also heavily involved in local civic affairs
and
9
philanthropic organizations in order to focus customers on products and services
at a personal level. The Company occasionally sponsors community events and
holds grand opening ceremonies for its new branches to which local dignitaries
are invited to speak and participate in the festivities. The Company engages a
marketing firm to assist with creative design, research, public relations, media
placement, etc., as well as assisting with promoting the overall image of the
Company to the general public and investment community. During 2004, the Company
hired a Director of Marketing to manage this expanding area of the Company and
coordinate the marketing efforts on a full-time basis.
o Value. Among other things, the Company offers attractive rates for
its financial products, including its certificates of deposit and
checking accounts. This pricing structure has been successful in
attracting depositors who are motivated by the Company's rates, as
well as by the variety of individualized services it promotes and
offers.
o Convenience and Service. The Company's personnel focus upon serving
the individual needs of the Company's customers. For example, senior
management personnel are accessible on very short notice, before,
during, and after normal banking hours, by way of mobile phones and
other means.
Management intends to continue to market the Company's services through a
combination of advertising campaigns, public relations activities and local
affiliations. While the key messages of value, convenience, service and
reliability will continue to play a major role in the Company's marketing and
public relations efforts, management may also focus on targeted groups, such as
professionals, in addition to small to medium-sized local businesses.
A vital part of the Company's marketing plan is the execution of a public
relations strategy. Many traditional public relations methods are used in
promoting its services. Management pursues media coverage, including general
press, industry periodicals and other media covering banking and finance,
consumer issues and special interests. Press releases, quarterly shareholder
reports, media alerts and presentations are used to announce new banking
services as they are added.
Competition
Commercial banking in the southeastern United States is extremely competitive,
due in large part to interstate branching. Currently, many of the Company's
competitors are significantly larger and have greater resources. The Company
continues to encounter significant competition from a number of sources,
including bank holding companies, financial holding companies, commercial banks,
thrift institutions, credit unions, and other financial institutions and
financial intermediaries. The Company competes in its market areas with some of
the largest banking organizations in the Southeast, several of which have
numerous branches in NC and VA. The Company's competition is not limited to
financial institutions based in NC and VA. The enactment of federal legislation
authorizing nationwide interstate banking has greatly increased the size and
financial resources of some of the Company's competitors. Consequently, many of
its competitors have substantially higher lending limits due to their greater
total capitalization, and many perform functions for their customers, such as
trust services, that the Company generally does not offer. The Company primarily
relies on providing quality products and services at a competitive price within
the market area. As a result of interstate banking legislation, the Company's
market is open to future penetration by banks located in other states provided
that the other states allow their domestic banking institutions to acquire NC
banking institutions, thereby increasing competition.
In its Triad Region, as of June 2004, the Company competed with 15 commercial
banks and two savings institutions, as well as numerous credit unions. As of
that date, the Company competed with 13 commercial banks, two savings
institution and several credit unions in its Wilmington Region. In its
10
Norton Region, as of June 2004, the Company competed with 8 commercial banks. As
of that date, the Company competed with 13 commercial banks in its Harrisonburg
Region.
Employees
All employees during 2004 were compensated by the Bank or its subsidiaries. On
December 31, 2004, the Company had approximately 255 full-time and 14 part-time
employees. None of the Company's employees are represented by a collective
bargaining unit, and we have not experienced any type of strike or labor
dispute. We consider our relationship with our employees to be very good, as
they are extremely important to our long-term success. The Board and management
continually seek ways to enhance their benefits and well being.
Available Information
The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports available free
of charge on its internet website www.fnbsoutheast.com, as soon as reasonably
practicable after the reports are electronically filed or furnished to the SEC.
Any materials that the Company files with the SEC may be read and/or copied at
the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549.
Public information may be obtained by calling the SEC at 1-800-SEC-0330. These
filings are also accessible on the SEC's website at www.sec.gov.
Additionally, the Company's corporate governance policies, including the
charters of the Audit, Compensation, and Nominating and Corporate Governance
committees; and the Code of Business Conduct and Ethics may also be found under
the "Investor Information" section of the Company's website. The Company elects
to disclose any amendments to or waivers of any provisions of its Code of
Business Conduct and Ethics applicable to its principal executive officers and
senior financial officers on its website. A written copy of the foregoing
corporate governance policies is available upon written request to the Company.
Supervision and Regulation
Bank and financial holding companies and commercial banks are extensively
regulated under both federal and state law. The following is a brief summary of
certain statutes and rules and regulations that affect or will affect the
Company, the Bank, and the Bank's subsidiaries. This summary is qualified in its
entirety by reference to the particular statute, and regulatory provisions
referred to below, and is not intended to be an exhaustive description of the
statutes or regulations applicable to the business of the Company and the Bank.
Supervision, regulation and examination of the Company and the Bank by the
regulatory agencies are intended primarily for the protection of depositors
rather than shareholders of the Company. Statutes and regulations which contain
wide-ranging proposals for altering the structures, regulations, and competitive
relationship of financial institutions are introduced regularly. The Company
cannot predict whether or in what form any proposed statute or regulation will
be adopted or the extent to which the business of the Company and the Bank may
be affected by such statute or regulation.
General. There are a number of obligations and restrictions imposed on financial
holding companies and bank holding companies and their depository institution
subsidiaries by law and regulatory policy that are designed to minimize
potential loss to the depositors of such depository institutions and the FDIC
insurance funds in the event the depository institution becomes in danger of
default or in default. For example, to avoid receivership of an insured
depository institution subsidiary, a holding company is required to guarantee
the compliance of any insured depository institution subsidiary that may become
"undercapitalized" with the terms of any capital restoration plan filed by such
subsidiary with its appropriate federal banking agency up to the lesser of (i)
an amount equal to 5% of the bank's total assets
11
at the time the bank became undercapitalized or (ii) the amount which is
necessary (or would have been necessary) to bring the bank into compliance with
all acceptable capital standards as of the time the bank fails to comply with
such capital restoration plan. The Company, as a registered financial holding
company, is subject to the regulation of the Federal Reserve. Under a policy of
the Federal Reserve with respect to holding company operations, a holding
company is required to serve as a source of financial strength to its subsidiary
depository institutions and to commit resources to support such institutions in
circumstances where it might not do so absent such policy. The Federal Reserve
under the BHCA also has the authority to require a holding company to terminate
any activity or to relinquish control of a nonbank subsidiary (other than a
nonbank subsidiary of a bank) upon the Federal Reserve's determination that such
activity or control constitutes a serious risk to the financial soundness and
stability of any bank subsidiary of the holding company.
In addition, insured depository institutions under common control are required
to reimburse the FDIC for any loss suffered by its deposit insurance funds as a
result of the default of a commonly controlled insured depository institution or
for any assistance provided by the FDIC to a commonly controlled insured
depository institution in danger of default. The FDIC may decline to enforce the
cross-guarantee provisions if it determines that a waiver is in the best
interest of the deposit insurance funds. The FDIC's claim for damages is
superior to claims of stockholders of the insured depository institution or its
holding company but is subordinate to claims of depositors, secured creditors
and holders of subordinated debt (other than affiliates) of the commonly
controlled insured depository institutions.
As a result of the Company's ownership of the Bank, the Company is also
registered under the bank holding company laws of North Carolina. Accordingly,
the Company is also subject to regulation and supervision by the Commissioner.
Capital Adequacy Guidelines for Holding Companies. The Federal Reserve has
adopted capital adequacy guidelines for bank holding companies and banks that
are members of the Federal Reserve system and have consolidated assets of $150
million or more. Bank and financial holding companies subject to the Federal
Reserve's capital adequacy guidelines are required to comply with the Federal
Reserve's risk-based capital guidelines. Under these regulations, the minimum
ratio of total capital to risk-weighted assets is 8%. At least half of the total
capital is required to be "Tier I capital," principally consisting of common
stockholders' equity, noncumulative perpetual preferred stock, and a limited
amount of cumulative perpetual preferred stock, less certain goodwill items. The
remainder ("Tier II capital") may consist of a limited amount of subordinated
debt, certain hybrid capital instruments and other debt securities, perpetual
preferred stock, and a limited amount of the general loan loss allowance. In
addition to the risk-based capital guidelines, the Federal Reserve has adopted a
minimum Tier I capital (leverage) ratio, under which a holding company must
maintain a minimum level of Tier I capital to average total consolidated assets
of at least 3% in the case of a holding company which has the highest regulatory
examination rating and is not contemplating significant growth or expansion. All
other holding companies are expected to maintain a Tier I capital (leverage)
ratio of at least 1% to 2% above the stated minimum.
Capital Requirements for the Bank. The Bank, as a NC commercial bank, is
required to maintain a surplus account equal to 50% or more of its paid-in
capital stock. As a NC chartered, FDIC-insured commercial bank that is a member
of the Federal Reserve System, it is also subject to capital requirements
imposed by the Federal Reserve. Under Federal Reserve regulations, member banks
must maintain a minimum ratio of qualifying capital to weighted risk assets
equal to 8%. At least half of the total capital is required to be Tier I
Capital, with the remainder consisting of Tier II Capital. In addition to the
foregoing risk based capital guidelines, member banks which receive the highest
rating in the examination process and are not anticipating or experiencing any
significant growth, must maintain a minimum level of Tier I Capital to total
assets of 3%. Member banks, which do not fall within the
12
foregoing standards, are required to maintain higher capital ratios. The Bank
exceeded all applicable minimum capital requirements as of December 31, 2004.
Dividend and Repurchase Limitations. The Company must obtain Federal Reserve
approval prior to repurchasing common stock for consideration in excess of 10%
of its net worth during any twelve-month period unless the Company (i) both
before and after the redemption satisfies capital requirements for "well
capitalized" state member banks; (ii) received a one or two rating in its last
examination; and (iii) is not the subject of any unresolved supervisory issues.
Although the payment of dividends and repurchase of stock by the Company are
subject to certain requirements and limitations of NC corporate law, except as
set forth in this paragraph, neither the Commissioner nor the FDIC have
promulgated any regulations specifically limiting the right of the Company to
pay dividends and repurchase shares. However, the ability of the Company to pay
dividends or repurchase shares is dependent upon the Company's receipt of
dividends from the Bank.
NC commercial banks, such as the Bank, are subject to legal limitations on the
amounts of dividends they are permitted to pay. The Bank may pay dividends from
undivided profits, which are determined by deducting and charging certain items
against actual profits, including any contributions to surplus required by NC
law. Also, an insured depository institution, such as the Bank, is prohibited
from making capital distributions, including the payment of dividends, if, after
making such distribution, the institution would become "undercapitalized" (as
such term is defined in the applicable law and regulations).
Deposit Insurance Assessments. The Bank is subject to insurance assessments
imposed by the FDIC. Under current law, the insurance assessment to be paid by
members of the Bank Insurance Fund, such as the Bank, shall be as specified in a
schedule required to be issued by the FDIC. FDIC assessments for deposit
insurance range from 0 to 27 basis points per $100 of insured deposits,
depending on the institution's capital position and other supervisory factors.
Federal Home Loan Bank System. The Federal Home Loan Bank ("FHLB") system
provides a central credit facility for member institutions. In December 2004,
the FHLB of Atlanta implemented a new capital plan. As a member of the FHLB of
Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta in an
amount at least equal to 0.20% (or 20 basis points) of the Bank's total assets
at the end of each calendar year, plus 4.5% of its outstanding advances
(borrowings) from the FHLB of Atlanta under the new activity-based stock
ownership requirement. On December 31, 2004, the Bank was in compliance with
this requirement.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"), as
implemented by regulations of the FDIC, an insured institution has a continuing
and affirmative obligation consistent with its safe and sound operation to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions, nor does it limit an institution's
discretion to develop, consistent with the CRA, the types of products and
services that it believes are best suited to its particular community. The CRA
requires the federal banking regulators, in connection with their examinations
of insured institutions, to assess the institutions' records of meeting the
credit needs of their communities, using the ratings of "outstanding,"
"satisfactory," "needs to improve," or "substantial noncompliance," and to take
that record into account in its evaluation of certain applications by those
institutions. All institutions are required to make public disclosure of their
CRA performance ratings. The Bank received a "satisfactory" rating in its last
CRA examination, which was conducted during July 2004.
Prompt Corrective Action. The FDIC has broad powers to take corrective action to
resolve the problems of insured depository institutions. The extent of these
powers will depend upon whether the institution in question is "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
13
undercapitalized," or "critically undercapitalized." Under the regulations, an
institution is considered "well capitalized" if it has (i) a total risk-based
capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or
greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any
order or written directive to meet and maintain a specific capital level for any
capital measure. An "adequately capitalized" institution is defined as one that
has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I
risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or
greater (or 3% or greater in the case of an institution with the highest
examination rating). An institution is considered (A) "undercapitalized" if it
has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I
risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than
4% (or 3% in the case of an institution with the highest examination rating);
(B) "significantly undercapitalized" if the institution has (i) a total
risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital
ratio of less than 3% or (iii) a leverage ratio of less than 3% and (c)
"critically undercapitalized" if the institution has a ratio of tangible equity
to total assets equal to or less than 2%. At December 31, 2004, the Bank had the
requisite capital levels to qualify as "well capitalized".
Changes in Control. The BHCA prohibits the Company from acquiring direct or
indirect control of more than 5% of the outstanding voting stock or
substantially all of the assets of any bank or savings bank or merging or
consolidating with another bank or financial holding company or savings bank
holding company without prior approval of the Federal Reserve. Similarly,
Federal Reserve approval (or, in certain cases, non-disapproval) must be
obtained prior to any person acquiring control of the Company. Control is
conclusively presumed to exist if, among other things, a person acquires more
than 25% of any class of voting stock of the Company or controls in any manner
the election of a majority of the directors of the Company. Control is presumed
to exist if a person acquires more than 10% of any class of voting stock and the
stock is registered under Section 12 of the Exchange Act or the acquiror will be
the largest shareholder after the acquisition.
Federal Securities Law. The Company has registered its common stock with the SEC
pursuant to Section 12(g) of the Exchange Act. As a result of such registration,
the proxy and tender offer rules, insider trading reporting requirements, annual
and periodic reporting and other requirements of the Exchange Act are applicable
to the Company.
Transactions with Affiliates. Under current federal law, depository institutions
are subject to the restrictions contained in Section 22(h) of the Federal
Reserve Act with respect to loans to directors, executive officers and principal
shareholders. Under Section 22(h), loans to directors, executive officers and
shareholders who own more than 10% of a depository institution (18% in the case
of institutions located in an area with less than 30,000 in population), and
certain affiliated entities of any of the foregoing, may not exceed, together
with all other outstanding loans to such person and affiliated entities, the
institution's loans-to-one-borrower limit (as discussed below). Section 22(h)
also prohibits loans above amounts prescribed by the appropriate federal banking
agency to directors, executive officers and shareholders who own more than 10%
of an institution, and their respective affiliates, unless such loans are
approved in advance by a majority of the board of directors of the institution.
Any "interested" director may not participate in the voting. The FDIC has
prescribed the loan amount (which includes all other outstanding loans to such
person), as to which such prior board of director approval is required, as being
the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further,
pursuant to Section 22(h), the Federal Reserve requires that loans to directors,
executive officers, and principal shareholders be made on terms substantially
the same as offered in comparable transactions with non-executive employees of
the Bank. The FDIC has imposed additional limits on the amount a bank can loan
to an executive officer.
Loans to One Borrower. The Bank is subject to the loans to one borrower limits
imposed by the North Carolina Office of the Commissioner of Banks (the
"Commissioner"), which are substantially the same as those applicable to
national banks. Under these limits, no loans and extensions of credit to any
borrower
14
outstanding at one time and not fully secured by readily marketable collateral
shall exceed 15% of the unimpaired capital and unimpaired surplus of the bank.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of unimpaired capital and unimpaired surplus.
Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act enacted in 1999 (the
"GLB Act") dramatically changed various federal laws governing the banking,
securities and insurance industries. The GLB Act has expanded opportunities for
banks and bank holding companies to provide services and engage in other
revenue-generating activities that previously were prohibited to them. However,
this expanded authority also may present us with new challenges as our larger
competitors are able to expand their services and products into areas that are
not feasible for smaller, community oriented financial institutions. The GLB Act
likely will have a significant economic impact on the banking industry and on
competitive conditions in the financial services industry generally.
USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to
the terrorist attacks that occurred in New York, Pennsylvania and Washington,
D.C. on September 11, 2001. The Act is intended to strengthen the ability of
U.S. law enforcement and the intelligence community to work cohesively to combat
terrorism on a variety of fronts. The potential impact of the Act on financial
institutions of all kinds is significant and wide ranging. The Act contains
sweeping anti-money laundering and financial transparency laws and requires
various regulations, including standards for verifying customer identification
at account opening, and rules to promote cooperation among financial
institutions, regulators, and law enforcement entities in identifying parties
that may be involved in terrorism or money laundering.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act of 2002 was
signed into law and became some of the most sweeping federal legislation
addressing accounting, corporate governance and disclosure issues. The impact of
the Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and
imposes significant new requirements for public company governance and
disclosure requirements. Some of the provisions of the Sarbanes-Oxley Act became
effective immediately while others are still in the process of being
implemented.
In general, the Sarbanes-Oxley Act mandates important new corporate governance
and financial reporting requirements intended to enhance the accuracy and
transparency of public companies' reported financial results. It establishes new
responsibilities for corporate chief executive officers, chief financial
officers and audit committees in the financial reporting process and creates a
new regulatory body to oversee auditors of public companies. It backs these
requirements with new SEC enforcement tools, increases criminal penalties for
federal mail, wire and securities fraud, and creates new criminal penalties for
document and record destruction in connection with federal investigations. It
also increases the opportunity for more private litigation by lengthening the
statute of limitations for securities fraud claims and providing new federal
corporate whistleblower protection.
The economic and operational effects of this new legislation on public
companies, including us, have been and will continue to be significant in terms
of the time, resources and costs associated with complying with the new law.
Other. Additional regulations require annual examinations of all insured
depository institutions by the appropriate federal banking agency, with some
exceptions for small, well-capitalized institutions and state chartered
institutions examined by state regulators, and establish operational and
managerial, asset quality, earnings and stock valuation standards for insured
depository institutions, as well as compensation standards.
15
The Bank is subject to examination by the Federal Reserve and the Commissioner.
In addition, it is subject to various other state and federal laws and
regulations, including state usury laws, laws relating to fiduciaries, consumer
credit and equal credit, fair credit reporting laws and laws relating to branch
banking. The Bank, as an insured North Carolina commercial bank, is prohibited
from engaging as a principal in activities that are not permitted for national
banks, unless (i) the FDIC or the Federal Reserve, as it is a member bank,
determines that the activity would pose no significant risk to the appropriate
deposit insurance fund and (ii) the Bank is, and continues to be, in compliance
with all applicable capital standards.
Limits on Rates Paid on Deposits and Brokered Deposits. Regulations promulgated
by the FDIC place limitations on the ability of insured depository institutions
to accept, renew or roll-over deposits by offering rates of interest which are
significantly higher than the prevailing rates of interest on deposits offered
by other insured depository institutions having the same type of charter in such
depository institution's normal market area. Under these regulations, "well
capitalized" depository institutions may accept, renew or roll-over such
deposits without restriction, "adequately capitalized" depository institutions
may accept, renew or roll-over such deposits with a waiver from the FDIC
(subject to certain restrictions on payments of rates) and "undercapitalized"
depository institutions may not accept, renew, or roll-over such deposits. The
regulations contemplate that the definitions of "well capitalized," "adequately
capitalized" and "undercapitalized" will be the same as the definitions adopted
by the FDIC to implement the corrective action provisions discussed below.
Only a "well capitalized" (as defined in the statute as significantly exceeding
each relevant minimum capital level) depository institution may accept brokered
deposits without prior regulatory approval. "Adequately capitalized" banks may
accept brokered deposits with a waiver from the FDIC (subject to certain
restrictions on payment of rates), while "undercapitalized" banks may not accept
brokered deposits. The regulations contemplate that the definitions of "well
capitalized," "adequately capitalized" and "undercapitalized" are the same as
the definitions adopted by the agencies to implement the prompt corrective
action provisions discussed below.
The Company does not believe that these regulations have had or will have a
material adverse effect on the Bank's current operations.
Taxation. Federal Income Taxation. Financial institutions such as the Bank are
subject to the provisions of the Internal Revenue Code of 1986, as amended (the
"Code") in the same general manner as other corporations. However, banks which
meet certain definitional tests and other conditions prescribed by the Code may
benefit from certain favorable provisions regarding their deductions from
taxable income for annual additions to their bad debt reserve. The Bank may
compute its addition to the bad debt reserve under the specific charge-off
method or the reserve method. Under the reserve method, the addition to bad
debts from losses on loans is computed by use of the experience method. Use of
the experience method requires minimum additions to the reserve based on the
amount allowable under a six-year moving average. The Code also provides annual
limits on the amount the Bank can add to its reserves for loan losses.
State Taxation. Under NC law, the Bank is subject to corporate income taxes at a
6.90% rate and an annual franchise tax at a rate of 0.15%.
Future Requirements. Statutes and regulations, which contain wide-ranging
proposals for altering the structures, regulations and competitive relationships
of financial institutions, are introduced regularly. Neither the Company nor the
Bank can predict whether or what form any proposed statute or regulation will be
adopted or the extent to which the business of the Company or the Bank may be
affected by such statute or regulation.
16
Item 2. Properties
The Company's executive offices were relocated to 1501 Highwoods Boulevard in
Greensboro, NC during April 2004. The Company's principal support and
operational functions are located at 202 South Main Street in Reidsville, NC.
The Company has 13 banking offices located in NC and four banking offices in VA.
The location of these banking offices, their form of occupancy and deposits as
of December 31, 2004, information about drive-up ATM facilities, and the year
each office was opened is described in the accompanying table:
Location Owned or Leased Deposits ATM Year
-------------------------------------------- --------------- --------- --- ----
202 South Main Street, Reidsville, NC (1) Owned $ 101,524 Yes 1910
1501 Highwoods Boulevard, Greensboro, NC (2) Leased -- Yes 2004
1646 Freeway Drive, Reidsville, NC Owned 37,042 Yes 1972
202 Turner Drive, Reidsville, NC Owned 34,022 Yes 1969
801 South Van Buren Road, Eden, NC Owned 36,896 Yes 1996
151 North Fieldcrest Road, Eden, NC Leased 16,038 No 1996
605 North Highway Street, Madison, NC Owned 20,984 Yes 1997
9570 US 29 Business, Ruffin, NC Leased 12,256 No 1997
2132 New Garden Road, Greensboro, NC Owned 78,423 Yes 1997
4638 Hicone Road, Greensboro, NC Owned 26,000 Yes 2000
3202 Randleman Road, Greensboro, NC Owned 33,084 Yes 2000
704 South College Road, Wilmington, NC Leased 107,653 Yes 1997
7210 Wrightsville Avenue, Wilmington, NC Leased 14,678 Yes 2000
301 East Fremont Street, Burgaw, NC Leased 32,094 Yes 1999
3025 Springbank Lane, Charlotte, NC (3) Leased -- No 2004
19460 Old Jetton Road, Cornelius, NC (3) Leased -- No 2004
600 Trent Street, Norton, VA Owned 60,801 Yes 1973
700 East Morgan Avenue, Pennington Gap, VA Owned 19,735 Yes 1979
440 South Main Street, Harrisonburg, VA Owned 61,883 Yes 1988
1925 Reservoir Street, Harrisonburg, VA Owned 31,172 Yes 2003
----------
(1) Original office opened in a different location in 1910. Current office
opened in 1980. Consists of 27,000 square feet in a two story building;
former headquarters location; scheduled to undergo extensive renovations
in 2005; will continue to serve as a full service branch as well as
becoming the Operations Center for the Company.
(2) The current headquarters office opened in 2004.
(3) Mortgage loan production offices.
Item 3. Legal Proceedings
In the ordinary course of operations, the Company and the Bank are party to
various legal proceedings. In the opinion of management, neither the Company nor
the Bank is involved in any pending legal proceedings other than routine,
non-material proceedings occurring in the ordinary course of business.
Item 4. Submission of Matters To a Vote of Security Holders
There were no matters submitted to a vote of the security holders of the Company
during the fourth quarter of the Company's fiscal year ended December 31, 2004.
17
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
Market Prices and Dividend Policies
The Company's common stock is traded on The Nasdaq Stock Market National Market
System under the symbol "FNBF." The following table shows the high and low sale
price of the Company's common stock on The Nasdaq Stock Market National Market
System(1), based on published financial sources, for each of the last two fiscal
years. The table also reflects the per share amount of cash dividends paid for
each share during the fiscal quarter for each of the last two fiscal years. Only
one cash dividend was paid during each of the fiscal quarters listed.(1)
Calendar Period High Low Dividends Paid
-------------------------------- ------- ------- --------------
Quarter ended March 31, 2003 $ 14.88 $ 13.24 $ 0.11
Quarter ended June 30, 2003 16.32 14.10 0.11
Quarter ended September 30, 2003 17.78 14.57 0.11
Quarter ended December 31, 2003 20.90 17.01 0.12
Quarter ended March 31, 2004 $ 20.75 $ 19.53 $ 0.12
Quarter ended June 30, 2004 20.30 16.82 0.12
Quarter ended September 30, 2004 19.47 16.38 0.12
Quarter ended December 31, 2004 23.35 18.79 0.14
----------
(1) For comparative purposes, the sale prices and dividends paid
amounts shown in the accompanying table have been restated to
reflect the 5-for-4 stock split effected as a 25% stock dividend,
effective December 29, 2003.
As of March 14, 2005, there were approximately 1,652 beneficial owners of the
Company's common stock, including 1,248 holders of record of the Company's
common stock. For a discussion as to any restrictions on the Company or the
Bank's ability to pay dividends, reference Item 1 - Supervision and Regulation
of the Company and the Bank.
See also Note 18 in the Notes to Consolidated Financial Statements of this
Annual Report on Form 10-K. See also "Supervision and Regulation - Regulation of
the Company, Dividend and Repurchase Limitations" and "Regulation of the Bank -
Dividends."
The accompanying table details, by month, the information related to the
activity related to the share repurchase program approved by the Company's Board
of Directors in July 2004 authorizing the repurchase of up to 275,124 shares of
the Company's outstanding common stock. The program was publicly announced in
the month of approval.
Stock Repurchase Program - Approved July 2004
-------------------------------------------------------
(a) (b) (c) (d)
Total Number of Maximum Number
Shares Average Price Cumulative Number of of Shares That May Yet Be
Period Purchased Paid Per Share Shares Purchased Purchased
- ------------------- --------------- -------------- -------------------- -------------------------
October 1, 2004 to
October 31, 2004 ... 13,800 $ 19.65 44,203 230,921
November 1, 2004 to
November 30, 2004 .. 18,811 $ 20.46 63,014 212,110
December 1, 2004 to
December 31, 2004 .. 13,400 $ 21.78 76,414 198,710
18
Recent Sales of Unregistered Securities
The Company did not sell any of its securities in the last three fiscal years,
which were not registered under the Securities Act of 1933, as amended, except
that it granted options to employees or directors to acquire an aggregate of
324,033 shares of its common stock at a weighted average exercise price of
$16.14 per share pursuant to the Company's Omnibus Equity Compensation Plan.
Item 6. Selected Financial Data
The annual selected historical financial data presented in the accompanying
table are derived from the audited consolidated financial statements for FNB
Financial Services Corporation and Subsidiary. As this information is only a
summary, you should read it in conjunction with the historical financial
statements (and related notes) of the Company and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
herein.
19
Selected Consolidated Financial Data
(In thousands, except per share, ratio and other data) At and For the Year Ended December 31,
---------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
Income Statement Data:
Net interest income $ 29,385 $ 24,822 $ 23,753 $ 21,705 $ 22,659
Provision for credit losses 1,275 1,431 1,300 1,278 2,525
Noninterest income 8,086 7,425 5,285 4,740 2,891
Noninterest expense 23,766 19,567 17,429 15,838 16,100
Net income 8,341 7,460 6,782 6,478 4,602
Balance Sheet Data:
Assets $ 865,335 $ 780,926 $ 734,032 $ 704,825 $ 685,904
Loans (1) 663,425 581,384 563,600 535,345 500,637
Allowance for credit losses 7,353 7,124 7,059 6,731 6,311
Deposits 724,286 641,907 605,005 586,760 569,451
Other borrowings 45,000 55,500 52,500 30,000 41,000
Shareholders' equity 70,430 65,750 64,333 62,708 56,392
Per Common Share Data (5):
Net income, basic $ 1.52 $ 1.35 $ 1.19 $ 1.14 $ 0.83
Net income, diluted (2) 1.46 1.30 1.17 1.13 0.82
Cash dividends declared .50 0.45 0.42 0.41 0.36
Book value 12.69 12.00 11.52 10.98 10.05
Tangible book value 12.53 11.82 11.48 10.92 9.98
Other Data:
Branch offices 17 18 17 17 18
Full-time employees 255 225 188 204 196
Performance Ratios:
Return on average assets 1.02% 0.98% 0.97% 0.91% 0.72%
Return on average equity 12.29 11.55 10.63 10.75 8.96
Net interest margin (tax equivalent) 3.94 3.53 3.57 3.25 3.83
Dividend payout 34.25 33.68 35.55 35.94 44.42
Efficiency (3) 62.28 59.65 59.71 59.05 62.20
Asset Quality Ratios:
Allowance for credit losses to period end loans 1.11% 1.23% 1.25% 1.26% 1.26%
Allowance for credit losses to period end
nonperforming loans (4) 209.16 136.30 191.87 297.04 195.87
Net charge-offs to average loans 0.17 0.24 0.18 0.17 0.14
Nonperforming assets to period end loans
and foreclosed property (4) 1.36 1.78 0.94 0.92 0.84
Capital and Liquidity Ratios:
Average equity to average assets 8.32% 8.52% 9.09% 8.45% 8.07%
Leverage capital 8.20 8.40 8.50 8.60 8.20
Tier 1 risk based capital 10.20 10.70 11.20 11.60 11.30
Total risk based capital 11.30 11.90 12.50 12.80 12.50
Average loans to average deposits 90.98 91.69 96.17 85.96 87.91
Average loans to average deposits and borrowings 83.07 83.39 86.85 79.63 79.22
- ----------
(1) Loans net of unearned income, before allowance for credit losses.
(2) Assumes the exercise of outstanding dilutive options to acquire common
stock. See Note 14 to the Company's consolidated financial statements.
(3) Computed by dividing noninterest expense by the sum of taxable
equivalent net interest income and noninterest income.
(4) Nonperforming loans and nonperforming assets include loans past due 90
days or more that are still accruing interest.
(5) Per share data has been restated to reflect the 5-for-4 stock split,
effected as a 25% stock dividend, effective December 29, 2003.
20
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following presents management's discussion and analysis of our financial
condition and results of operations and should be read in conjunction with the
financial statements and related notes included elsewhere in this annual report.
This discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ significantly from those
anticipated in these forward-looking statements as a result of various factors.
All share data have been adjusted to give retroactive effect to stock splits and
stock dividends. The following discussion is intended to assist in understanding
the financial condition and results of operations of the Company.
Executive Overview
Significant Accomplishments. In the opinion of the management of FNB Financial
Services Corporation, the Company's most significant accomplishments during 2004
were:
o We relocated the Company's headquarters to Greensboro, NC, which
enhanced our ability to employ and retain personnel with the skills
and experience necessary to continue to execute our strategic plan
and to promote our penetration of this significant urban market.
o We began the execution of our management succession plan with the
promotion of Pressley A. Ridgill to President of the Bank.
o We expanded our core management team with the promotion of key
personnel and the addition of several members.
o We continued to execute upon the Company's strategic plan of
expanding our markets, products and services.
o Diluted net income per share increased 12.3%.
o Net interest income increased 18.4%.
o Asset quality continued to improve; all significant credit quality
ratios improved year-to-year.
Challenges. The achievement of the Company's strategic initiatives and long-term
financial goals is subject to many uncertainties. The challenges, which in the
opinion of management are most likely to have a near-term effect on operations,
are presented below:
o Volatility of interest rates.
o Building revenue momentum.
o Improving efficiency.
o The economic environment in our core markets.
o Costs associated with the current heightened regulatory environment.
o Expanding our core management team.
o Volatility in the mortgage banking business.
o Intense price competition.
General
The Company earned $8.34 million in 2004, an 11.8% increase over the $7.46
million earned in 2003. Diluted net income per share of $1.46 for 2004
represents a 12.3% increase over diluted net income per share of $1.30 in 2003.
The Bank of Tazewell purchased selected loans and assumed the deposits of the
Bank's Richlands, VA branch during April 2004. The Bank transferred $15.0
million in deposit accounts and $7.3 million in loan accounts in the
transaction. We recognized approximately $700,000 in net gain on the sale. Also
during April, we realized approximately $125,000 gain from the sale of the fixed
assets associated with the Richlands, VA branch. Total assets at December 31,
2004 stood at $865.3 million compared to $780.9 million one year earlier. The
increase in assets is primarily attributable to an $82.0
21
million increase in gross loans. Gross loans at December 31, 2004 totaled $663.4
million, up from $581.4 million at yearend 2003. Investment securities, which is
the next largest component of assets, totaled $141.6 million at December 31,
2004, a 1.5% decrease from the balance of $143.7 million a year ago.
During 2004, deposits increased 12.8% to $724.3 million at yearend. Borrowings,
comprised of federal funds purchased, retail repurchase agreements, and FHLB
advances, totaled $66.5 million at December 31, 2004, compared to $70.9 million
at the prior yearend. Shareholders' equity increased 7.1% to $70.4 million at
yearend 2004. Book value per share was $12.69 at December 31, 2004.
The Company's subsidiary bank, FNB Southeast, is a NC chartered commercial bank
that, as of December 31, 2004, operated thirteen banking offices in NC and four
banking offices in VA. The Bank operates two wholly owned subsidiaries. FNB
Southeast Investment Services, Inc. was formed in 2000 to provide retail
investment products and services. FNB Southeast Mortgage Corporation was formed
in 2001 to provide mortgage banking services.
Financial Condition at December 31, 2004 and 2003
The Company's consolidated assets of $865.3 million at yearend 2004 reflect an
increase of 10.8% over the previous year, following an increase of 6.4% in 2003.
Total average assets increased 7.6% to $815.6 million in 2004, compared to
$758.1 million in 2003. During 2004, the Company experienced a 6.3% increase in
average earning assets. Average earning assets totaled $764.1 million in 2004,
compared to $718.9 million in 2003. The increase in 2004 was primarily
attributable to a 7.2% growth in average outstanding loans. The increase in
average outstanding loans was funded primarily by an 8.0% rise in average
deposits resulting from successful deposit marketing campaigns during 2004.
Gross loan growth during 2004 was $82.0 million, with outstanding loans up 14.1%
at yearend, which followed increases of 3.2% in 2003 and 5.3% in 2002. Loans
secured by real estate totaled $442.2 million in 2004 and represented 66.7% of
total loans, compared with 64.1% at yearend 2003. Within this category,
commercial real estate loans increased 4.2% during fiscal 2004 to a level of
$166.7 million, while residential real estate loans rose 19.5% to $113.4 million
and construction loans increased 37.7% to $162.1 million. Commercial, financial
and agricultural loans totaled $86.2 million and represented 13.0% of total
loans at the end of 2004, and 15.5% at yearend 2003. Consumer loans increased
15.9% during 2004, led by increased home equity loans. Management believes the
Company is not dependent on any single customer or group of customers
concentrated in a particular industry, the loss of whose deposits or whose
insolvency would have a material adverse effect on operations.
Investment securities (at amortized cost) totaled $142.4 million at yearend
2004, a 1.1% decline from $143.9 million at yearend 2003. U.S. Government agency
and mortgage backed securities continue to represent the major share of the
total portfolio, and totaled $104.9 million, or 58.2% of the portfolio at
yearend 2004, compared to $106.8 million, or 74.2% of the portfolio one year
earlier. Management believes that the additional risk of owning agency
securities over U.S. Treasury securities is negligible and has capitalized on
the favorable spreads available on the former. State and municipal obligations
amounted to $31.9 million at yearend, compared to $32.6 million a year earlier.
The Company's investment strategy is to achieve acceptable total returns, while
investing in securities with relatively short maturity dates as necessary to
fund loan growth. To this end, the Company has consistently categorized the
entire portfolio as "Available for Sale," which it believes offers the greatest
amount of flexibility in managing a total return concept. The table, "Investment
Securities," presents the composition of the securities portfolio for the last
three years, as well as information about cost, fair value and weighted average
yield.
Total deposits increased $82.4 million to $724.3 million at December 31, 2004,
resulting in a 12.8% increase over $641.9 million in deposits one year earlier.
This increase was driven by an $8.8 million, or
22
12.6%, increase in demand deposits and a $73.5 million, or 61.9%, increase in
savings, NOW and MMI accounts; while time deposit growth was relatively flat.
The market for deposits remains fiercely competitive and the Company relies on
appropriate pricing and quality customer service to retain and increase its
retail deposit base. During the year, the Company had several featured products
to generate new deposits and increase the customer base. For commercial
customers, the Company is focused on building a total relationship, which will
foster growth in both loans and deposits. In addition to traditional checking
accounts, the Company offers a cash management sweep account, with outstanding
balances of $7.9 million at yearend.
In order to attract additional deposits when necessary, the Company maintains
membership in an electronic network that allows it to post interest rates and
attract deposits nationally. As of December 31, 2004, FNB Southeast had three of
such certificates of deposit totaling $7.6 million, with an overall rate of
1.74% for this portfolio. This certificate portfolio decreased by $18.4 million
during 2004. The Company also held one brokered certificate of deposit totaling
$7.4 million at December 31, 2004 maturing during 2005, compared to $25.0
million one year earlier. Brokered certificates typically have an original term
of twelve to twenty-four months. The decrease in bulletin board deposits and
brokered deposits is attributable to the increase of in-market deposits
generated in 2004. Brokered deposits may continue to decrease during 2005;
however, these deposits can be utilized for future balance sheet funding as
necessary.
The Company also has a credit facility available with the FHLB of Atlanta.
Borrowing capacity is established at 17% of the Bank's total assets as submitted
on regulatory financial reports. The Company also utilized a portion of its
approximately $145 million line with the FHLB to fund earning assets. FHLB
borrowings totaled $45.0 million at yearend. Management continues to believe
this is a cost effective and prudent alternative to deposit balances, since a
particular amount, term and structure may be selected to meet its current needs.
Financial Condition at December 31, 2003 and 2002
The Company's consolidated assets of $780.9 million at December 31, 2003 reflect
an increase of 6.4% over the previous year. Total average assets increased 8.1%
to $758.1 million in 2003, compared to $701.5 million in 2002. During 2003, the
Company experienced a 7.2% increase in average earning assets. Average earning
assets totaled $718.9 million in 2003, compared to $670.6 million in 2002. The
increase in 2003 was primarily attributable to a 26.1% growth in the average
investment securities balance, combined with an increase in average outstanding
loans. The increase in the average balance of securities was attributable to a
combination of a slightly weaker loan demand and a 9.6% rise in average deposits
resulting from successful deposit marketing campaigns during 2003.
Gross loan growth during 2003 was $17.8 million, with outstanding loans up 3.2%
at yearend, which followed increases of 5.3% in 2002 and 6.9% in 2001. Loans
secured by real estate totaled $372.6 million in 2003 and represented 64.1% of
total loans, compared with 67.1% at yearend 2002. Within this category,
commercial real estate loans decreased 6.3% during fiscal 2003 to a level of
$160.0 million, while residential real estate loans decreased 20.5% to $94.9
million and construction loans increased 34.3% to $117.8 million. Commercial,
financial and agricultural loans totaled $90.2 million and represented 15.5% of
total loans at the end of 2003 and 2002. Consumer loans increased 20.4% during
2003, led by increased home equity loans. Management believes the Company is not
dependent on any single customer or group of customers concentrated in a
particular industry, the loss of whose deposits or whose insolvency would have a
material adverse effect on operations.
Investment securities (at amortized cost) of $143.9 million at yearend 2003 were
up $17.5 million, or 13.9%, from $126.4 million at yearend 2002. U.S. Government
agency securities continue to represent
23
the major share of the total portfolio, and totaled $106.8 million, or 74.2% of
the portfolio at yearend 2003, compared to $115.3 million, or 91.2% of the
portfolio one year earlier. Management believes that the additional risk of
owning agency securities over U.S. Treasury securities is negligible and has
capitalized on the favorable spreads available on the former. State and
municipal obligations increased $25.6 million and amounted to at $32.6 million
at yearend. The increase in municipal securities in 2003 is attributable to the
favorable tax effected yield, compared to other available securities. The
Company's investment strategy is to achieve acceptable total returns, while
investing in securities with relatively short maturity dates as necessary to
fund loan growth. To this end, the Company has consistently categorized the
entire portfolio as "Available for Sale," which it believes offers the greatest
amount of flexibility in managing a total return concept. The table, "Investment
Securities," presents the composition of the securities portfolio for the last
three years, as well as information about cost, fair value and weighted average
yield.
Total deposits increased $36.9 million to $641.9 million at December 31, 2003,
resulting in a 6.1% increase over $605.0 million in deposits one year earlier.
This increase was driven by an $8.3 million, or 13.5% increase in demand
deposits, a $9.7 million, or 2.2% increase in time deposits and an $18.8
million, or 18.8% increase in savings, NOW and MMI accounts.
The market for deposits remains fiercely competitive and the Company relies on
appropriate pricing and quality customer service to retain and increase its
retail deposit base. During the year, the Company had several featured products
to generate new deposits and increase the customer base. For commercial
customers, the Company is focused on building a total relationship, which will
foster growth in both loans and deposits. In addition to traditional checking
accounts, the Company offers a cash management sweep account, with outstanding
balances of $6.7 million at 2003 yearend.
In order to attract additional deposits when necessary, the Company maintains
membership in an electronic network that allows it to post interest rates and
attract deposits nationally. As of December 31, 2003, FNB Southeast had 10 of
such certificates of deposit totaling $989,000, with an overall rate of 3.60%
for this portfolio. This certificate portfolio decreased by $10.5 million during
2003. The Company also held three brokered certificates of deposit totaling
$25.0 million at December 31, 2003, compared to $44.5 million one year earlier.
The brokered certificates have an original term of twelve to twenty-four months
with maturities of $25.0 million in 2004. The decrease in bulletin board
deposits and brokered deposits is attributable to the increase of in market
deposits generated in 2003. Brokered deposits may continue to decrease during
2004.
The Company also has a credit facility available with the FHLB of Atlanta.
Borrowing capacity is established at 17% of the Bank's total assets as submitted
on regulatory financial reports. The Company also utilized a portion of it's
approximately $130 million line with the FHLB to fund earning assets. FHLB
borrowings totaled $55.5 million at yearend. Management continues to believe
this is a cost effective and prudent alternative to deposit balances, since a
particular amount, term and structure may be selected to meet its current needs.
Net Interest Income
Like most financial institutions, the primary component of our earnings is net
interest income. Net interest income is the difference between interest income,
principally from loans and investments, and interest expense, principally on
customer deposits and borrowings. Changes in net interest income result from
changes in volume and changes in interest rates earned and paid. By volume, we
mean the average dollar level of interest-earning assets and interest-bearing
liabilities. Spread refers to the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities,
and margin refers to net interest income divided by average interest-earning
assets. Spread and margin are influenced by the levels and relative mix of
interest-earning assets and interest-bearing liabilities, as well as by levels
of noninterest-bearing liabilities. During the years ended December 31, 2004,
2003 and 2002, our average
24
interest-earning assets were $764.1 million, $718.9 million, and $670.6 million,
respectively. During these same years, our net interest margins were 3.63%,
3.16% and 3.07%, respectively.
Average Balances and Average Rates Earned and Paid. The following table sets
forth, for the years 2002 through 2004, information with regard to average
balances of assets and liabilities, as well as the total dollar amounts of
interest income from interest-earning assets and interest expense on
interest-bearing liabilities, resultant yields or costs, net interest income,
net interest spread, net interest margin and ratio of average interest-earning
assets to average interest-bearing liabilities. Average loans include
nonaccruing loans, the effect of which is to lower the average yield.
Average Balance Sheets and Net Interest Income Analysis
Fully Taxable Equivalent Basis
(Dollars in thousands)
Year Ended December 31,
---------------------------------------------------------------
2004 2003
------------------------------ ------------------------------
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
--------- -------- ------- --------- -------- -------
Interest earning assets:
Loans, net (1) $ 613,522 $ 39,609 6.46% $ 572,472 $ 36,196 6.32%
Taxable investment securities 102,139 3,146 3.08 108,863 4,045 3.72
Tax-exempt investment 33,377 2,035 6.10 26,389 1,652 6.26
securities (2)
Other securities 4,414 180 4.08 3,746 172 4.59
Overnight deposits 10,644 194 1.82 7,476 84 1.12
--------- -------- --------- --------
Total earning assets 764,096 45,164 5.91 718,946 42,149 5.86
Non-earning assets:
Cash and due from banks 20,210 16,566
Premises and equipment 13,587 12,630
Other assets 24,918 17,028
Less: Allowance for credit
loss (7,230) (7,116)
--------- ---------
Total assets $ 815,581 $ 758,054
========= =========
Interest bearing liabilities:
Savings and NOW $ 52,263 66 0.13% $ 50,947 125 0.25%
MMI 98,516 2,070 2.10 55,630 791 1.42
Time deposits 447,940 11,423 2.55 452,156 14,274 3.16
Federal funds purchased,
borrowed funds and
securities sold under
agreements to repurchase 64,140 1,528 2.38 62,203 1,575 2.53
--------- -------- --------- --------
Total interest bearing
liabilities 662,859 15,087 2.28 620,936 16,765 2.70
Other liabilities and
shareholder's equity
Demand deposits 75,712 65,592
Other liabilities 9,150 6,938
Shareholders' equity 67,860 64,588
--------- ---------
Total liabilities and
shareholders' equity $ 815,581 $ 758,054
========= =========
Net interest income and net
yield on earning assets (3) $ 30,077 3.94% $ 25,384 3.53%
======== ==== ======== ====
Interest rate spread (4) 3.63% 3.16%
==== ====
- ----------
25
Average Balance Sheets and Net Interest Income Analysis (cont'd)
Fully Taxable Equivalent Basis
(Dollars in thousands)
Year Ended December 31,
------------------------------
2002
------------------------------
Interest Average
Average Income/ Yield/
Balance Expense Rate
--------- -------- -------
Interest earning assets:
Loans, net (1) $ 547,816 $ 37,199 6.79%
Taxable investment securities 100,418 5,375 5.35
Tax-exempt investment 5,766 452 7.84
securities (2)
Other securities 4,082 232 5.68
Overnight deposits 12,548 205 1.63
--------- --------
Total earning assets 670,630 43,463 6.48
Non-earning assets:
Cash and due from banks 14,597
Premises and equipment 11,072
Other assets 12,159
Less: Allowance for credit
loss (6,928)
---------
Total assets $ 701,530
=========
Interest bearing liabilities:
Savings and NOW $ 45,172 231 0.51%
MMI 50,531 1,061 2.10
Time deposits 416,226 16,730 4.02
Federal funds purchased,
borrowed funds and
securities sold under 61,121 1,533 2.51
agreements to repurchase
--------- --------
Total interest bearing
liabilities 573,050 19,555 3.41
Other liabilities and
shareholder's equity
Demand deposits 57,708
Other liabilities 6,982
Shareholders' equity 63,790
---------
Total liabilities and
shareholders' equity $ 701,530
=========
Net interest income and net
yield on earning assets (3) $ 23,908 3.57%
======== =====
Interest rate spread (4) 3.07%
=====
- ----------
(1) The average loan balances include nonaccruing loans and only interest
income actually collected and recognized.
(2) The fully taxable equivalent basis is computed using a federal tax rate of
34%.
(3) Net yield on earning assets is computed by dividing net interest income by
average earning assets.
(4) Earning asset yield minus interest bearing liabilities rate
Rate/Volume Analysis
The following table analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's
rate), (ii) changes attributable to rate (changes in rate multiplied by the
prior period's volume), and (iii) net change (the sum of the previous columns).
The change attributable to both rate and volume (changes in
26
rate multiplied by changes in volume) has been allocated equally to both the
changes attributable to volume and the changes attributable to rate.
Analysis of Interest Changes Due To Volume and Rates
Fully Taxable Equivalent Basis
(In thousands)
Year Ended December 31,
-------------------------------------------------------------------
2004 compared with 2003 2003 compared with 2002
-------------------------------- --------------------------------
Volume (2) Rate (2) Total Volume (2) Rate (2) Total
Variance Variance Variance Variance Variance Variance
---------- -------- -------- ---------- -------- --------
Interest Income:
Loans, net $ 2,595 $ 818 $ 3,413 $ 1,674 $ (2,677) $ 1,003)
Taxable investment securities (250) (649) (899) 452 (1,782) (1,330)
Tax-exempt investment securities (1) 437 (54) 383 1,617 (417) 1,200
Other securities 31 (23) 8 (19) (41) (60)
Overnight deposits 36 74 110 (83) (38) (121)
Federal funds sold and securities
purchased under the agreement to
resale -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Total change 2,849 166 3,015 3,641 (4,955) (1,314)
-------- -------- -------- -------- -------- --------
Interest expense:
Savings and NOW 3 (62) (59) 30 (136) (106)
MMI 610 669 1,279 107 (377) (270)
Time deposits (133) (2,718) (2,851) 1,444 (3,900) (2,456)
Federal funds purchased, borrowed
funds and securities sold under
agreements to repurchase 49 (96) (47) 27 15 42
-------- -------- -------- -------- -------- --------
Total change 530 (2,208) (1,678) 1,609 (4,399) (2,790)
-------- -------- -------- -------- -------- --------
Increase (decrease) in net interest
income $ 2,319 $ 2,374 $ 4,693 $ 2,032 $ (557) $ 1,476
======== ======== ======== ======== ======== ========
- ----------
(1) Yields on nontaxable securities are stated on a fully taxable equivalent
basis, assuming a 34% Federal tax rate.
The adjustments made to convert to a fully taxable equivalent basis were
$692,000 for 2004, $562,000 for 2003, and $155,000 for 2002.
(2) Changes attributable to both volume and rate have been allocated
proportionately.
Results of Operations -- Years Ended December 31, 2004 and 2003
Net Income. Our net income for 2004 was $8.34 million, an increase of $880,000
from net income of $7.46 million earned in 2003. Diluted net income per share
was $1.46, compared to $1.30 a year earlier. We have continued to experience
strong growth, with total assets averaging $815.6 million during the current
year as compared to $758.1 million in 2003, an increase of 7.6%. Our net
interest income after provision for credit losses increased $4.72 million over
the prior year. During 2004, the Federal Reserve began increasing the federal
funds rate at 25 basis point increments at its June meeting and, ultimately,
increased the federal funds rate a total of 125 basis points during the year.
Paralleling this rise in the federal funds rate was an increase in the prime
rate from 4.0% at the beginning of the year to 5.25% at yearend 2004. Our growth
in earning assets, combined with a rising interest rate environment led to an
increase of $4.56 million in net interest income. Our noninterest expense growth
included the completion of a new corporate headquarters building as well as
personnel and other infrastructure costs associated with the expansion of our
business.
Net Interest Income. Net interest income represents the gross profit from the
lending and investment activities of a banking organization and is the most
significant factor affecting the earnings of the Company. Net interest income is
influenced by changes in interest rates, volume and the mix of these various
components. Net interest income on a fully taxable equivalent basis for 2004 was
$30.1 million, which represented an 18.5% increase from the previous year level
of $25.4 million. Actual net interest income for 2004 was $29.4 million, an
18.4% increase from $24.8 million recorded in 2003. Average total earning assets
increased $45.2 million, or 6.3%, during 2004 as compared to 2003, while our
average
27
yield rose 41 points, from 3.53% in 2003 to 3.94% in 2004. The rates earned on a
significant portion of our loans adjust when index rates such as prime rate
changes. Conversely, most of our interest-bearing liabilities, including
certificates of deposit and borrowings, have rates fixed until maturity. As a
result interest rate increases generally result in an immediate positive impact
to interest income on loans, with a more delayed impact on interest expense
because increases in interest costs will occur only upon renewals of
certificates of deposit or borrowings. Average loans outstanding during the 2004
fiscal year were $613.5 million, compared to $572.5 million in 2003, an increase
of 7.2%. Average investment securities during 2004 were $139.9 million, compared
to $139.0 million in 2003.
Trends in interest rates turned upward for the year, as the Federal Reserve
increased the federal funds rate by a total of 125 basis points with 25 basis
point increases coming in June, August, September, November, and December 2004.
As a result, the prime lending rate rose to 5.25% at December 31, 2004 from
4.00% at December 31, 2003. This had the effect of increasing both the earning
asset yield and the interest bearing liability rate. During 2004, the rise in
the earning asset yield outpaced the increase in the interest bearing liability
rate.
The weighted average yield on earning assets increased to 5.91% for 2004,
compared to 5.86% for 2003. This increase in the asset yield in 2004 was
primarily attributable to the increased yield on loans, combined with a
decreased yield on investment securities. During the current year, the yield on
loans increased 14 basis points to 6.46% from 6.32% in 2003. This rise is due to
variable rate loans that repriced higher during the year in response to
increases in the underlying index, and new fixed rate loans originated at higher
rates.
The weighted average rate paid on interest bearing liabilities was 2.28%,
compared to 2.70% in 2003. Average interest bearing deposits for 2004 totaled
$598.7 million, a 7.2% increase from $558.7 million in 2003. The overall rate
for interest bearing deposits declined 46 basis points to 2.26% in 2004,
compared to 2.72% in the prior year. The overall rate on borrowings was 2.38% in
2004, compared to 2.53% a year earlier. Average borrowings totaled $64.1 million
in 2004 and $62.2 million in 2003, an increase of 3.1%.
The table, "Average Balance Sheets and Net Interest Income Analysis," summarizes
net interest income and average yields earned and rates paid for the years
indicated, on a tax equivalent basis. The table, "Analysis of Interest Changes
Due to Volume and Rates," presents the changes in interest income and interest
expense attributable to volume and rate changes between the years indicated.
Provision for Credit Losses. We recorded a $1.3 million provision for credit
losses for the year ended December 31, 2004, compared to a $1.4 million
provision in the prior year. Provisions for credit losses are charged to income
to bring our allowance for credit losses to a level deemed appropriate by
management. See "Asset Quality" for a discussion of the factors relevant to the
provision/allowance for credit losses.
Noninterest Income. Noninterest income of $8.1 million in 2004 was $661,000, or
8.9%, more than the previous year amount of $7.4 million. Net gains on sale of
securities for 2004 totaled $109,000, compared to $564,000 in 2003. Service
charges on deposit accounts increased to $3.8 million from $3.6 million in 2003.
The Company was able to capitalize on increased fees and increased volume of
demand deposits and other accounts with service charges. Revenues from our
mortgage banking operation increased 10.6%, rising from $2.0 million in 2003 to
$2.2 million in 2004 as we began to realize increased revenues from our
wholesale mortgage division. Additionally, we realized approximately $700,000 in
net gains on the sale of our Richlands, VA banking operation and approximately
$125,000 in net gains from the sale of the fixed assets associated with the
branch.
Noninterest Expense. Because of our continued strong growth we have experienced
increases in every major component of our noninterest expenses. For the year
ended December 31, 2004, our noninterest
28
expense increased $4.2 million, or 21.5%. Personnel expense of $12.4 million in
2004 exceeded the previous year expense of $10.5 million by $1.9 million, or
18.0% and reflects the addition of a wholesale mortgage division, increased
staffing costs associated with the relocation of our corporate headquarters,
expansion of our commercial lending staff, and the additional costs arising from
the normal expansion of business, along with normal increases in salaries and
benefits. At December 31, 2004, we had approximately 255 full-time and 14
part-time employees, compared with 225 full-time and 12 part-time employees at
December 31, 2003. Occupancy and equipment expenses totaled $4.3 million for
2004, which was up 20.0% from $3.6 million in 2003, reflecting the expenses
associated with our corporate headquarter relocation and investments in
technology to support our banking operations. Other expenses were $7.1 million,
compared to $5.0 million in 2003, reflecting the increased volume of business
activity, principally increases in lending and growth in deposit accounts.
Provision for Income Taxes. The Company's provision for income taxes totaled
$4.1 million for 2004, an increase of $300,000, or 7.9%, compared to 2003. Our
effective tax rates for the years ended 2004 and 2003 were 32.9% and 33.7%,
respectively. The decline in the effective rate from 2003 to 2004 reflects the
implementation of investment strategies that resulted in a reduction in the
consolidated income tax provision. The increase in the provision for 2004,
compared to the prior year, results from higher pretax income, offset in part by
a lower effective tax rate. Overall, the effective tax rate is attributable to
the current expense required to provide an adequate provision for income taxes
at the end of 2004 and 2003.
Results of Operations -- Years Ended December 31, 2003 and 2002
Net Income. Our net income for 2003 was $7.46 million, an increase of $678,000
from net income of $6.78 million earned in 2002. Diluted net income per share
was $1.30, compared to $1.17 a year earlier. We have continued to experience
strong growth, with total assets averaging $758.1 million during the current
year as compared to $701.5 million in 2002, an increase of 8.1%. Our net
interest income after provision for credit losses increased $938,000 over the
prior year.
Net Interest Income. Net interest income represents the gross profit from the
lending and investment activities of a banking organization and is the most
significant factor affecting the earnings of the Company. Net interest income is
influenced by changes in interest rates, volume and the mix of these various
components. Net interest income on a fully taxable equivalent basis for 2003 was
$25.4 million, which represented a 6.2% increase from $23.9 million in 2002.
Actual net interest income for 2004 was $24.8 million, a 4.5% increase from
$23.8 million recorded in 2003. The increase in net interest income is primarily
attributable to lower overall rates paid on time deposits. The net effect was to
increase the interest rate spread, which is the average yield on earning assets
minus the average rate paid on interest bearing liabilities. While the average
yield on earning assets declined in 2003, that decline was more than offset by
the reduction in average rates paid on interest bearing liabilities. Average
loans outstanding during the 2003 fiscal year were $572.5 million, compared to
$547.8 million in 2002, an increase of 4.5%. Average investment securities
during 2003 were $139.0 million compared to $110.3 million in 2002.
Trends in interest rates remained downward for the year, as the Federal Reserve
decreased the federal funds rate by 25 basis points in July 2003, which followed
a 50 basis point interest rate reduction in November 2002. As a result, the
prime lending rate declined to 4.00% at December 31, 2003 from 4.25% at December
31, 2002. This had the effect of decreasing both the earning asset yield and the
interest bearing liability rate. During 2003, the decline in the interest
bearing liability rate outpaced the decline in the earning asset yield.
Additionally, the decline in interest rates resulted in increases in the fair
market value of the Company's investment portfolio during 2003. The increased
fair value resulted in increased liquidity, due to securit