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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number 0-15572
FIRST BANCORP
(Exact Name of Registrant as Specified in its Charter)
North Carolina 56-1421916
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(State of Incorporation) (I.R.S. Employer Identification Number)
341 North Main Street, Troy, North Carolina 27371-0508
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (910)576-6171
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Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, $5 PAR VALUE
(Title of each class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [ X ] YES [ ] NO
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy of information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to the Form 10-K. [ ]
The aggregate market value of the voting stock, Common Stock, $5 par
value, held by non-affiliates of the registrant, based on the average bid and
asked prices of the Common Stock on January 31, 1999 as reported on the NASDAQ
National Market System, was approximately $56,461,000. Shares of Common Stock
held by each officer and director and by each person who owns 5% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
The number of shares of the Registrant's Common Stock outstanding on
January 31, 1999 was 3,022,230.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement to be filed pursuant to
Regulation 14A are incorporated herein by reference into Part III.
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CROSS REFERENCE INDEX
PART I Business:
Item I General Description
Statistical Information
Net Interest Income
Average Balances and Net Interest Income Analysis
Volume and Rate Variance Analysis
Provision for Loan Losses
Noninterest Income
Noninterest Expenses
Income Taxes
Distribution of Assets and Liabilities
Securities Portfolio Composition and Maturities
Loans
Nonperforming Assets
Allowance for Loan Losses and Loan Loss Experience
Deposits
Interest Rate Risk (Including Quantitative
and Qualitative Disclosures About Market Risk)
Off-Balance Sheet Risk
Return on Assets and Equity
Liquidity
Capital Resources, Components and Ratios
Year 2000 Issue
Inflation
Accounting Changes
Forward-Looking Statements
Item 2 Properties
Item 3 Legal Proceedings
Item 4 Submission of Matters to a Vote of Shareholders
PART II
Item 5 Market for the Registrant's Common Stock and Related
Shareholder Matters
Item 6 Selected Financial Data
Item 7 Management's Discussion and Analysis of Results of
Operations and Financial Condition
Item 7A Quantitative and Qualitative Disclosures About Market Risk
Item 8 Financial Statements and Supplementary Data:
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Income for each of the years in the
three-year period ended December 31, 1998
Consolidated Statements of Comprehensive Income for each of the
years in the three-year period ended December 31, 1998
Consolidated Statements of Shareholders' Equity for each of the
years in the three-year period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the years
in the three-year period ended December 31, 1998
Notes to Consolidated Financial Statements
Independent Auditors' Report
Selected Consolidated Financial Data
Quarterly Financial Summary
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures
PART III
Item 10 Directors and Executive Officers of the Registrant; Compliance
with Section 16 (a) of the Exchange Act
Item 11 Executive Compensation
Item 12 Security Ownership of Certain Beneficial Owners and Management
Item 13 Certain Relationships and Related Transactions
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports of Form 8-K
SIGNATURES
* Information called for by Part III (Items 10 through 13) is incorporated
herein by reference to the Registrant's definitive Proxy Statement for the
1999 Annual Meeting of Shareholders to be filed with Securities and
Exchange Commission.
PART I
Item 1. Business
General Description
The Company
First Bancorp (the "Company") is a one-bank holding company. The principal
activity of the Company is the ownership and operation of First Bank (the
"Bank"), a state chartered bank with its main office in Troy, North Carolina.
The Company also owns and operates two nonbank subsidiaries, Montgomery Data
Services, Inc. ("Montgomery Data"), a data processing company, and First Bancorp
Financial Services, Inc. ("First Bancorp Financial"), which currently owns and
operates various real estate. The Company also controls First Bank Insurance
Services, Inc. ("First Bank Insurance"), an insurance agency acquired in 1994 as
a subsidiary of the Bank. On December 29, 1995, the insurance agency operations
of First Bank Insurance were divested. First Bank Insurance continues to be a
subsidiary of the Bank, but is inactive at this time.
The Company was incorporated in North Carolina on December 8, 1983, as
Montgomery Bancorp, for the purpose of acquiring 100% of the outstanding common
stock of the Bank through stock-for-stock exchanges. On December 31, 1986, the
Company changed its name to First Bancorp to conform its name to the name of the
Bank, which had changed its name from Bank of Montgomery to First Bank in 1985.
The Bank was organized in 1934 and began banking operations in 1935 as the
Bank of Montgomery, named for the county in which it operated. With its 1995
acquisition of the Laurinburg and Rockingham offices of First Scotland Bank
("First Scotland") and its 1994 acquisition of Central State Bank ("Central
State"), High Point, North Carolina, the Bank operates in a 14 county area
centered in Troy, North Carolina. Troy, population 3,400, is located in the
center of Montgomery County, approximately 60 miles east of Charlotte, and 50
miles south of Greensboro. The Bank conducts business from 35 branches located
within a 80-mile radius of Troy, covering a geographical area from Maxton to the
southeast, to High Point to the north, Kannapolis to the west, and Lillington to
the east. Ranked by assets, the Bank was the 15th largest bank in North Carolina
as of December 31, 1998, according to the Office of the Commissioner of Banks.
The Bank provides a full range of banking services, including the accepting of
demand and time deposits, the making of secured and unsecured loans to
individuals and businesses, discount brokerage services and self-directed IRA's
(both offered through a contractual relationship with a brokerage firm). In
1998, as in recent prior years, the Bank accounted for substantially all of the
Company's consolidated net income.
The Company's principal executive offices are located at 341 North Main
Street, Troy, North Carolina 27371-0508, and its telephone number is (910)
576-6171. Unless the context otherwise requires, references to the "Company" in
this annual report on Form 10-K shall mean collectively First Bancorp and its
subsidiaries.
General Business
The Bank engages in a full range of banking activities, providing such
services as checking, savings, NOW and money market accounts and other time
deposits of various types; loans for business, agriculture, real estate,
personal uses, home improvement and automobiles; credit cards; debit cards;
letters of credit; investment and discount brokerage services; IRA's; safe
deposit box rentals; bank money orders; and electronic funds transfer services,
including wire transfers, automated teller machines, and bank-by-phone
capabilities. Because the majority of the Bank's customers are individuals and
small to medium-sized businesses located in the counties it serves, deposits and
loans are well diversified. There are no seasonal factors that would have any
material effect on the Bank's business, and the Bank does not rely on foreign
sources of funds or income.
Montgomery Data's primary business is to provide electronic data processing
services for the Bank, which accounted for 99% of its data processing revenues
in 1998 and 82% in both 1997 and 1996. Ownership and operation of Montgomery
Data allows the Company to do all of its electronic data processing without
paying fees for such services to an independent provider. Maintaining its own
data processing system also allows the Company to adapt the system to its
individual needs and to the services and products it offers. Although not a
significant source of income, Montgomery Data has historically made its excess
data processing capabilities available to area financial institutions for a fee.
The Company had one nonaffiliated customer in 1996 and for the first eleven
months of 1997, at which time the customer terminated its contract as a result
of being acquired by another institution and paid an early termination fee. The
Company did not have any nonaffiliated customers from December 1997 to December
1998. In December 1998, a contract was signed to provide data processing for a
nearby start-up bank. This customer is expected to contribute approximately
$40,000 in fees during 1999. Montgomery Data is not aggressively marketing this
service and has no other prospective customers at this time.
First Bancorp Financial was organized under the name of First Recovery in
September of 1988 for the purpose of providing a back-up data processing site
for Montgomery Data and other financial and non-financial clients. First
Recovery's back-up data processing operations were divested on August 1, 1994.
First Bancorp Financial now owns and leases the First Recovery building. First
Bancorp Financial periodically purchases parcels of real estate from the Bank
that were acquired through foreclosure. The parcels purchased consist of real
estate having various purposes. First Bancorp Financial actively pursues the
sale of these properties.
Territory Served and Competition
The Company serves primarily the south central area of the Piedmont region
of North Carolina, with offices in Anson, Cabarrus, Chatham, Davidson, Guilford,
Harnett, Lee, Montgomery, Moore, Randolph, Richmond, Robeson, Scotland and
Stanly counties. The Company's headquarters are located in Troy, Montgomery
County. The Company's 35 branches and facilities are all located in small
communities whose economies are based primarily on manufacturing and light
industry. Although the Company's market is predominantly small communities and
rural areas, the area is not dependent on agriculture. Textiles, furniture,
mobile homes, electronics, plastic and metal fabrication, forest products, food
products and cigarettes are among the leading manufacturing industries in the
trade area. Leading producers of socks, hosiery and area rugs are located in
Montgomery County. The Pinehurst area is a widely known golf resort and
retirement area. The High Point area is widely known for its furniture market.
Additionally, several of the communities served by the Company are "bedroom"
communities serving Charlotte and Greensboro in addition to smaller cities such
as Albermarle, Asheboro, High Point, Pinehurst and Sanford.
The banking laws of North Carolina allow state-wide branching, and
consequently commercial banking in the state is highly competitive. The Company
competes in its various market areas with, among others, several large
interstate bank holding companies that are headquartered in North Carolina.
These large competitors have substantially greater resources than the Company,
including broader geographic markets, higher lending limits and the ability to
make greater use of large-scale advertising and promotions. A significant number
of interstate banking acquisitions have taken place in the past decade, thus
further increasing the size and financial resources of some of the Company's
competitors, three of which are among the largest bank holding companies in the
nation. See "Supervision and Regulation" below for a further discussion of
regulations in the Company's industry that affect competition.
The Company competes not only against banking organizations, but also
against a wide range of financial service providers including federally and
state chartered savings and loan institutions, credit unions, investment and
brokerage firms and small-loan or consumer finance companies. Competition among
financial institutions of all types is virtually unlimited with respect to legal
ability and authority to provide most financial services. However, the Company
believes it has certain advantages over its competition in the areas it serves.
The Company seeks to maintain a distinct local identity in each of the
communities it serves and actively sponsors and participates in local civic
affairs. Most lending and other customer-related business decisions can be made
without delays associated with larger systems. Additionally, employment of local
managers and personnel in various offices and low turnover of personnel enable
the Company to establish and maintain long-term relationships with individual
and corporate customers.
Lending Policy and Procedures
Conservative lending policies and procedures and appropriate underwriting
standards are high priorities of the Bank. Loans are approved under the Bank's
written loan policy, which provides that lending officers, principally branch
managers, have sole authority to approve loans of various amounts up to $75,000.
Each of the Bank's regional senior lending officers has sole discretion to
approve secured loans in principal amounts up to $250,000 and together can
approve loans up to $1,000,000. Lending limits may vary depending upon whether
the loan is secured or unsecured.
The Bank's board of directors reviews and approves loans that exceed
management's lending authority, loans to officers, directors, and their
affiliates and, in certain instances, other types of loans. New credit
extensions are reviewed daily by the Bank's senior management and at least
monthly by the board of directors.
The Bank continually monitors its loan portfolio to identify areas of
concern and to enable management to take corrective action. Lending officers and
the board of directors meet periodically to review past due loans and portfolio
quality, while assuring that the bank is appropriately meeting the credit needs
of the communities it serves. Individual lending officers are responsible for
pursuing collection of past-due amounts and monitoring any changes in the
financial status of the borrowers.
The Bank's internal audit department evaluates specific loans and overall
loan quality at individual branches as part of its regular branch reviews. The
internal audit department also maintains its own estimate of the required amount
of allowance for loan losses needed for the overall Company which is compared to
the loan department's estimate for consistency. See "Allowance for Loan Losses
and Loan Loss Experience" in Item 7 below.
The Bank also contracts with an independent consulting firm to review new
loan originations meeting certain criteria, as well as assign risk grades to
existing credits meeting certain thresholds. The consulting firm's observations,
comments and risk grades are shared with the Company's audit committee of the
board of directors, and are considered by management in setting Bank policy, as
well as in evaluating the adequacy of the allowance for loan losses.
Investment Policy and Procedures
The Bank has adopted an investment policy designed to optimize the Bank's
income from funds not needed to meet loan demand in a manner consistent with
appropriate liquidity and risk objectives. Pursuant to this policy, the Bank may
invest in federal, state and municipal obligations, federal agency obligations,
public housing authority bonds, industrial development revenue bonds, Federal
National Mortgage Association ("FNMA"), Government National Mortgage Association
("GNMA") and Student Loan Marketing Association ("SLMA") securities. The policy
also contains maximum amounts that the Bank can invest in certain types of
securities, including, at December 31, 1998, a maximum of $30 million that can
be invested in certain collateralized mortgage obligations and mortgage-backed
securities. The Bank's investments must be rated at least BAA by Moody's or BBB
by Standard and Poor's. Securities rated below A are periodically reviewed for
creditworthiness. The Bank may purchase non-rated municipal bonds only if such
bonds are in the Bank's general market area and determined by the Bank to have a
credit risk no greater than the minimum ratings referred to above. Industrial
development authority bonds, which normally are not rated, are purchased only if
they are judged to possess a high degree of credit soundness to assure
reasonably prompt sale at a fair value.
The Company's investment officers implement the investment policy, monitor
the investment portfolio, recommend portfolio strategies, and report to the
Bank's investment committee. Reports of all purchases, sales, net profits or
losses and market appreciation or depreciation of the bond portfolio are
reviewed by the Company's board of directors each month. Once a quarter, the
Company's interest rate risk exposure is monitored by the board of directors.
Once a year, the written investment policy is reviewed by the board of directors
and the Bank's portfolio is compared with the portfolios of other North Carolina
banks of comparable size.
All of the Bank's securities are kept in safekeeping accounts at
correspondent banks.
Recent Acquisitions
As part of its operations, the Company regularly evaluates the potential
acquisition of or merger with, and holds discussions with, various financial
institutions.
On November 14, 1997, the Bank acquired a First Union National Bank branch
located in Lillington, North Carolina. Real and personal property acquired
totaled approximately $237,000 and deposits assumed totaled approximately
$14,345,000. No loans were included in the purchase.
On December 15, 1995, the Bank completed its cash acquisition of the
Laurinburg and Rockingham branch offices of First Scotland Bank. As of December
15, 1995, assets acquired were approximately $15.8 million. The acquisition
included earning assets of approximately $14.2 million, of which approximately
$8.9 million were loans. Deposit liabilities assumed were approximately $15
million.
On August 25, 1994, the Company completed its cash acquisition of Central
State Bank in High Point, North Carolina. Central State, a North Carolina
state-chartered commercial bank, had approximately $35 million in assets at the
time of the acquisition, with earning assets of approximately $32 million,
including approximately $27 million in loans. Central State also had
approximately $32 million in deposits at the time of the merger with the Bank.
For additional information on these acquisitions, please see Management's
Discussion and Analysis and note 2 to the consolidated financial statements.
Employees
As of December 31, 1998, the Company had 245 full-time and 41 part-time
employees. The Company is not a party to any collective bargaining agreements
and considers its employee relations to be good.
Supervision and Regulation
As a bank holding company, the Company is subject to supervision,
examination and regulation by the Board of Governors of the Federal Reserve
System and the North Carolina Banking Commission. The Bank is subject to
supervision and examination by the Federal Deposit Insurance Corporation and the
North Carolina Banking Commission. See also note 14 to the consolidated
financial statements.
Supervision and Regulation of the Company
The Company is a bank holding company within the meaning of the Bank
Holding Company Act of 1956, as amended (the "Bank Holding Company Act"), and is
required to register as such with the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board" or "FRB"). The Company also is regulated by
the North Carolina Commissioner of Banks (the "Commissioner") under the Bank
Holding Company Act of 1984.
A bank holding company is required to file with the Federal Reserve Board
quarterly reports and other information regarding its business operations and
those of its subsidiaries. It is also subject to examination by the Federal
Reserve Board and is required to obtain Federal Reserve Board approval prior to
making certain acquisitions of other institutions or voting securities. The
Commissioner of Banks is empowered to regulate certain acquisitions of North
Carolina banks and bank holding companies, issue cease and desist orders for
violations of North Carolina banking laws, and promulgate rules necessary to
effectuate the purposes of the Bank Holding Company Act of 1984.
Regulatory authorities have cease and desist powers over bank holding
companies and their nonbank subsidiaries where their actions would constitute a
serious threat to the safety, soundness or stability of a subsidiary bank. Those
authorities may compel holding companies to invest additional capital into
banking subsidiaries upon acquisition or in the event of significant loan losses
or rapid growth of loans or deposits.
The United States Congress and the North Carolina General Assembly have
periodically considered and adopted legislation that has resulted in, and could
result in further, deregulation of both banks and other financial institutions.
Such legislation could modify or eliminate geographic restrictions on banks and
bank holding companies and current restrictions on the ability of banks to
engage in certain nonbanking activities. For example, the Riegle-Neal Interstate
Banking Act, which was enacted several years ago, allows expansion of interstate
acquisitions by bank holding companies and banks. This and other legislative and
regulatory changes have increased the ability of financial institutions to
expand the scope of their operations, both in terms of services offered and
geographic coverage. Such legislative changes could place the Company in more
direct competition with other financial institutions, including mutual funds,
securities brokerage firms, insurance companies, and investment banking firms.
The effect of any such legislation on the business of the Company cannot be
predicted. The Company cannot predict what other legislation might be enacted or
what other regulations might be adopted or, if enacted or adopted, the effect
thereof.
Supervision and Regulation of the Bank
Federal banking regulations applicable to all depository financial
institutions, among other things, (i) provide federal bank regulatory agencies
with powers to prevent unsafe and unsound banking practices; (ii) restrict
preferential loans by banks to "insiders" of banks; (iii) require banks to keep
information on loans to major shareholders and executive officers; and (iv) bar
certain director and officer interlocks between financial institutions.
As a state chartered bank, the Bank is subject to the provisions of the
North Carolina banking statutes and to regulation by the Commissioner. The
Commissioner has a wide range of regulatory authority over the activities and
operations of the Bank, and the Commissioner's staff conducts periodic
examinations of banks and their affiliates to ensure compliance with state
banking regulations. Among other things, the Commissioner regulates the merger
and consolidations of state-chartered banks, the payment of dividends, loans to
officers and directors, recordkeeping, types and amounts of loans and
investments, and the establishment of branches. The Commissioner also has cease
and desist powers over state-chartered banks for violations of state banking
laws or regulations and for unsafe or unsound conduct that is likely to
jeopardize the interest of depositors.
The dividends that may be paid by the Bank to the Company are subject to
legal limitations under the North Carolina law. In addition, the regulatory
authorities may restrict dividends that may be paid by the Bank or the Company's
other subsidiaries. The ability of the Company to pay dividends to its
shareholders is largely dependent on the dividends paid to the Company by its
subsidiaries.
The Bank is a member of the Federal Deposit Insurance Corporation (the
"FDIC"), which currently insures the deposits of member banks. For this
protection, each bank pays a quarterly statutory assessment, based on its level
of deposits, and is subject to the rules and regulations of the FDIC. The FDIC
also is authorized to approve conversions, mergers, consolidations and
assumptions of deposit liability transactions between insured banks and
uninsured banks or institutions, and to prevent capital or surplus diminution in
such transactions where the resulting, continuing, or assumed bank is an insured
nonmember bank. In addition, the FDIC monitors the Bank's compliance with
several banking statutes, such as the Depository Institution Management
Interlocks Act and the Community Reinvestment Act of 1977. The FDIC also
conducts periodic examinations of the Bank to assess its compliance with banking
laws and regulations, and it has the power to implement changes in or
restrictions on a bank's operations if it finds that a violation is occurring or
is threatened.
Neither the Company nor the Bank can predict what other legislation might
be enacted or what other regulations might be adopted, or if enacted or adopted,
the effect thereof on the Bank's operations.
See "Capital Resources" under Item 7 - Management's Discussion and Analysis
below for a discussion of regulatory capital requirements.
Item 2. Properties
The main offices of First Bancorp, First Bank and First Bancorp Financial
are located in a three-story building in the central business district of Troy,
North Carolina. The building houses administrative, training and bank teller
facilities. The Bank's Operations Division, including customer accounting
functions, offices and operations of Montgomery Data Services, and offices for
loan operations, are housed in a one-story steel frame building approximately
one-half mile west of the main office. The Company operates 35 branches and
facilities, including the main office, in the trade area as follows: Troy - main
office and two additional full service branches and one teller-window facility;
Albemarle, Asheboro, High Point, and Sanford - two full service branches in
each; Pinehurst - one full service branch and one teller-window facility;
Aberdeen, Archdale, Biscoe, Bennett, Candor, Denton, Kannapolis, Laurel Hill,
Laurinburg, Lillington, Locust, Maxton, Pinebluff, Polkton, Richfield, Robbins,
Rockingham, Seagrove, Seven Lakes, Southern Pines, and Vass - one full service
branch in each. Following the close of business on December 31, 1998, the
Company consolidated its 36th branch, Wagram, with its Laurinburg branch. The
Company owns all its premises except seven branch offices for which the land and
buildings are leased and two branch offices for which the land is leased but the
buildings are owned. There are no other options to purchase or lease additional
properties. The Company considers its facilities adequate to meet current needs
and idle or vacant properties are insignificant.
Item 3. Legal Proceedings
Various legal proceedings may arise in the ordinary course of business and
may be pending or threatened against the Company and/or its subsidiaries.
The Company is not involved in any pending legal proceedings which, in
management's opinion, could have a material effect on the consolidated financial
position of the Company.
Item 4. Submission of Matters to a Vote of Shareholders
No matters were submitted to the shareholders during the fourth quarter of
1998.
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder
Matters
The Company's common stock trades on the NASDAQ National Market System of
The NASDAQ Stock Market under the symbol FBNC. Tables 1 and 21, included in
"Management's Discussion and Analysis" below, set forth the high and low market
prices of the Company's common stock as traded by the brokerage firms that
maintain a market in the Company's common stock and the dividends declared for
the periods indicated. All per share amounts for reporting periods prior to 1996
have been restated from their originally reported amount to reflect the
two-for-one stock split that was distributed in September 1996. See "Business -
Supervision and Regulation" and note 14 to the consolidated financial statements
for a discussion of regulatory restrictions on the payment of dividends. As of
March 9, 1999 (the Company's record date for purposes of its 1999 Annual Meeting
of Shareholders), there were approximately 900 shareholders of record and an
estimated 800 shareholders whose stock is held in "street name."
Item 6. Selected Financial Data
Table 1 on page 28 sets forth selected financial data about the Company.
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Management's discussion and analysis is intended to assist readers in
understanding the Company's results of operations and changes in financial
position for the past three years. This review should be read in conjunction
with the consolidated financial statements and accompanying notes beginning on
page 40 of this report and the supplemental financial data contained in Tables 1
through 21 included with this discussion and analysis. All per share amounts for
periods prior to 1996 have been restated to reflect the two-for-one stock split
distributed on September 13, 1996 to shareholders of record on August 30, 1996.
Mergers and Acquisitions
On November 14, 1997, First Bank acquired a First Union National Bank
branch located in Lillington, North Carolina. Deposits assumed totaled
approximately $14,345,000. No loans were included in the purchase.
In the fourth quarter of 1995, First Bank completed its cash acquisition of
the Laurinburg and Rockingham branch offices of First Scotland Bank. Assets
acquired were approximately $15.8 million including earning assets of
approximately $14.2 million, of which approximately $8.9 million were loans.
Deposit liabilities assumed were approximately $15 million.
During the third quarter of 1994, the Company completed its cash
acquisition of Central State Bank in High Point, North Carolina. Central State
had approximately $35 million in assets with earning assets of approximately $32
million, including approximately $27 million in loans. Central State also had
approximately $32 million in deposits.
For additional information on these acquisitions, please see "Analysis of
Results of Operations" and "Analysis of Financial Condition" below and note 2 to
the consolidated financial statements.
ANALYSIS OF RESULTS OF OPERATIONS
Net interest income, the "spread" between earnings on interest-earning
assets and the interest paid on interest-bearing liabilities, constitutes the
largest source of the Company's earnings. Other factors that significantly
affect operating results are the provision for loan losses, noninterest income
such as service fees and noninterest expenses such as salaries, occupancy
expense, equipment expense and other overhead costs, as well as the effects of
income taxes.
Overview - 1998 Compared to 1997
Net income for 1998 was a record $5,683,000, a 13.4% increase over the
$5,012,000 earned in 1997. The 1998 net income amounted to $1.88 per basic
share, a 13.3% increase over the $1.66 basic earnings per share in 1997.
Earnings per share on a diluted basis amounted to $1.83 in 1998 compared to
$1.62 in 1997, an increase of 13.0%. 1998 results included $227,000 (pretax) in
gains from commercial loan sales, which are not common from a historical
perspective but are the type of gain that may occur again in the future under
certain circumstances. 1997 results included $168,000 (pretax) in nonrecurring
income related to the receipt of an early termination fee for a data processing
contract.
A primary contributor to the growth in earnings during 1998 was a 16.1%
increase in the Company's net interest income. This increase was a result of
strong growth in loans and deposits. Partially offsetting the effects on
earnings of the loan and deposit growth was a decrease in the Company's net
interest margin and a higher provision for loan losses. The increase in the
provision for loan losses from $575,000 in 1997 to $990,000 in 1998 was
primarily attributable to the significant loan growth experienced by the
Company, and not because of concerns about the Company's asset quality.
Also contributing to the growth in earnings was a 12.2% increase in the
Company's noninterest income, which grew from $4,150,000 in 1997 to $4,656,000
in 1998, an increase of $506,000. Core noninterest income, which the Company
defines as service charges on deposit accounts, commissions from insurance
sales, fees from presold mortgages, and other service charges, commissions, and
fees, increased $656,000, or 17.5%, during 1998, from $3,744,000 in 1997 to
$4,400,000 in 1998. Noninterest income not defined as "core" amounted to
$256,000 and $406,000 during 1998 and 1997, respectively, and is discussed in
more detail below.
Noninterest expenses increased $1,824,000, or 12.9%, from $14,088,000 in
1997 to $15,912,000 in 1998. These higher operating expenses were experienced in
all areas of the Company's operations and are associated with the growth in the
Company's branch network and customer base.
Overview - 1997 Compared to 1996
First Bancorp's net income for 1997 amounted to $5,012,000, or basic
earnings per share of $1.66, compared to $4,347,000, or basic earnings per share
of $1.44, for 1996. This represents a 15.3% increase in net income and basic
earnings per share over the prior year. Diluted earnings per share amounted to
$1.62 in 1998, a 13.3% increase over the $1.43 diluted earnings per share for
1996. Excluding the after-tax effects of nonrecurring gains of $103,000, or
$0.03 per share, in the fourth quarter of 1997 related to an early termination
fee of a data processing contract and $128,000, or $0.04 per share, in the third
quarter of 1996 related to a branch sale, the 1997 increase in net income and
basic earnings per share would have been 16.4% over 1996, and the increase in
diluted earnings per share would have been 14.4%.
The primary reason for the increase in net income in 1997 was a 16.2%
increase in net interest income that was a result of strong loan and deposit
growth. The provision for loan losses increased 76.9% over the prior year, which
is primarily a reflection of the Company providing for the loan growth
experienced during the year. Noninterest income decreased 6.7% for the year and
noninterest expenses increased 7.4% for the year. See additional discussion
below.
Net Interest Income
Net interest income on a taxable-equivalent basis amounted to $21,649,000
in 1998, $18,808,000 in 1997, and $16,256,000 in 1996.
Table 2 analyzes net interest income on a taxable-equivalent basis. The
Company's net interest income on a taxable-equivalent basis increased by 15% in
1998 and 16% in 1997. These increases were primarily a result of a 24% increase
in average earning assets in 1998 and a 12% increase in average earning assets
during 1997. The effects of the 24% increase in average earning assets on
taxable-equivalent net interest income in 1998 were partially offset by an
overall narrowing of the Company's interest rate spread. The Company's net
interest margin (net yield on average interest-earning assets) decreased 41
basis points to 5.24% in 1998 compared to 5.65% in 1997. The Company's interest
rate spread (the difference between the yield on interest-earning assets and the
rate paid on interest-bearing liabilities) decreased 39 basis points, from 4.96%
in 1997 to 4.57% in 1998.
A significant factor in this narrowing of the spread during 1998 was a
decrease in the average rate the Company earned on its loans. In 1998, the
average interest rate the Company earned on its loans decreased 40 basis points,
from 9.67% in 1997 to 9.27% in 1998. In addition to the effects of the average
prime rate decreasing from 8.44% in 1997 to 8.35% in 1998, other factors
contributing to the decline in the loan yield were a highly competitive market
and a continuing slight shift in the Company's loan mix from riskier, but higher
yielding, consumer installment loans, to less risky, but generally lower
yielding, real estate loans - see Table 10 and additional discussion below.
Another significant factor contributing to the narrowing of the interest rate
spread was a lower yield earned on taxable securities. The yield the Company
earned on its taxable securities decreased 35 basis points in 1998 to 6.37%,
compared to 6.72% in 1997. This decline was primarily due to generally declining
rates in the bond market that have occurred over the past few years, which has
resulted in lower reinvestment yields of matured and called bonds.
Despite the lower interest rate trend in the prime rate and bond market in
1998, the average rate that the Company paid on in its interest-bearing
liabilities increased 12 basis points from 4.03% to 4.15%. The increase in the
average rate paid on interest bearing deposits was due primarily to the Company
more competitively pricing its deposits to fund the strong loan growth and a
higher reliance on time deposits greater than $100,000, which generally carry
higher interest rates. Average time deposits greater than $100,000 increased 49%
during 1998 compared to a 25% increase for total average interest-bearing
liabilities.
In 1997, the effects of the 12% increase in average earning assets on
taxable-equivalent net interest income were enhanced by an increase in the
Company's interest rate spread by 19 basis points, from 4.77% in 1996 to 4.96%
in 1997. In 1997 the yield realized on earning assets increased by 22 basis
points from 1996, while the average yield the Company paid on interest-bearing
liabilities increased by only 3 basis points, resulting in an increase in net
interest margin of 20 basis points to 5.65% in 1997 from the 5.45% yield
realized in 1996. The increase in yield realized on earning assets was primarily
affected by a 20 basis point increase in the yield realized on loans that was
largely a result of the 25 basis point increase in the Bank's prime lending rate
that occurred in March 1997 and remained in effect for the remainder of the
year. The average rate paid on deposits, although 3 basis points higher in 1997
compared to 1996, was favorably impacted by higher growth in lower yielding
savings, NOW, and money market deposits (15% growth) versus higher yielding time
deposits (9% growth).
Changes in total interest income and total interest expense result from
changes in both volumes and rates in the related earning asset and
interest-bearing liability categories. Table 3 shows the quantitative effects on
net interest income of the changes in volumes and rates experienced by the
Company. As discussed above and illustrated in Table 3, changes in volumes have
been the primary cause of changes in the amounts of interest income and interest
expense recorded by the Company.
See additional information regarding net interest income on page 21 in the
section entitled "Interest Rate Risk"
Provision for Loan Losses
The provision for loan losses charged to operations is an amount sufficient
to bring the allowance for loan losses to an estimated balance considered
adequate to absorb potential losses inherent in the portfolio. Management's
determination of the adequacy of the allowance is based on an evaluation of the
portfolio, current economic conditions, historical loan loss experience and
other risk factors.
The Company made provisions for loan losses of $990,000 in 1998 compared to
$575,000 in 1997 and $325,000 in 1996. The increases in the provision for loan
losses in both 1998 and 1997 were largely in response to a higher volume of loan
growth experienced by the Company over the prior year's growth, as the Company's
asset quality ratios improved during both years. The Company originated $77.8
million in new loans, net of repayments, in 1998 compared to $57.5 million in
1997 and $11.5 million in 1996.
See the section entitled "Allowance for Loan Losses and Loan Loss
Experience" below for a more detailed discussion of the allowance for loan
losses. The allowance is monitored and analyzed regularly in conjunction with
the Bank's loan analysis and grading program, and adjustments are made to
maintain an adequate allowance for loan losses.
Noninterest Income
Noninterest income recorded by the Company amounted to $4,656,000 in 1998,
$4,150,000 in 1997, and $4,446,000 in 1996.
The 12.2% increase in 1998 noninterest income compared to 1997 was driven
by a $656,000, or 17.5%, increase in the amount of "core noninterest income"
earned by the Company. Core noninterest income, which includes service charges
on deposit accounts, commissions from insurance sales, fees from presold
mortgages, and other service charges, commissions, and fees increased from
$3,744,000 in 1997 to $4,400,000 in 1998. The 6.7% decrease in noninterest
income from 1996 to 1997 was driven largely by a $164,000 decrease in core
noninterest income. Noninterest income not defined as "core" amounted to
$256,000 during 1998, $406,000 in 1997, and $538,000 in 1996.
See Table 4 and the following discussion for an understanding of the
components of noninterest income.
Service charges on deposit accounts increased $182,000, or 7.5%, in 1998
after declining $148,000, or 5.8%, in 1997. The 1998 increase was due to, but
did not keep pace with, the growth rate of deposits. Management believes that
service charges on deposit accounts have not increased at the same rate as
deposits in the last two years primarily due to the mix of the Company's deposit
growth. The number of transaction accounts, which includes demand, savings, and
money market deposits and generates the majority of these fees, have not
increased at the same rate as the growth in time deposits, which have fewer
related fees. Additionally, the dollar increases that have occurred in the
outstanding balance of transaction accounts have been more heavily concentrated
in a fewer number of accounts with large balances. Another factor in the
essentially flat two-year deposit service charge growth relates to the Bank's
decision during 1996 to increase fees for certain services to make them more
commensurate with the related expenses the Bank incurred in providing the
services. Also, an internal emphasis was placed on collecting the fees for all
such services. This initially had the effect of increasing gross service fee
revenue which resulted in higher total service charge revenues in 1996 as
compared to 1995. Subsequently, management believes customers became more
cognizant of the higher fees and made efforts to reduce their use of these
services, which resulted in a decline in these same revenues for the Bank during
1997 compared to 1996.
Commissions from insurance sales decreased by $38,000 in 1998 and $35,000
in 1997 as a result of lower commission fee rates negotiated with brokers, as
well as a higher percentage of the Company's customers utilizing their home
equity lines of credit to finance consumer purchases versus obtaining consumer
installment loans, where the Company has typically brokered more insurance
policies.
Fees that the Company earns from presold mortgage loans grew by $253,000,
or 89% during 1998 and have more than doubled since 1996. A lower interest rate
environment conducive to mortgage loan refinancings and a dedicated staff of
mortgage loan originators are primarily responsible for this significant
increase.
Other service charges, commissions, and fees increased by $259,000, or 34%
in 1998 after being almost flat comparing 1997 to 1996. The primary reason for
the increase in this category of income was a surcharge that was levied on
non-customer ATM transactions beginning in March 1998. These revenues amounted
to $142,000 in 1998, which is helping to defray the significant capital
investment and maintenance expense incurred on ATM machines. The remainder of
the increase in this category is largely due to increases in transaction-related
fee activities such as credit card merchant income, check cashing fees, and
debit card income that were higher due to the growth in the Company's customer
base.
Noninterest income not classified as "core" by the Company in 1998 was
primarily comprised of gains from commercial loan sales. During 1998, the
Company sold approximately $6.4 million in newly originated commercial loans
that resulted in gains of $227,000. These sales were executed primarily to
maintain a proper balance between the amount of loans and deposits that the
Company maintains.
Noninterest income not classified as "core" by the Company in 1997 was
primarily comprised of data processing fees totaling $274,000 and an early
termination fee in the amount of $168,000 that Montgomery Data received from a
bank that terminated its data processing contract with Montgomery Data
prematurely. As noted earlier, Montgomery Data makes its excess data processing
capabilities available to area financial institutions for a fee. Montgomery Data
had one nonaffiliated customer in 1996 and for the first eleven months of 1997,
at which time the customer terminated its contract as a result of being acquired
by another institution and paid the early termination fee. Montgomery Data did
not have any nonaffiliated customers from December 1997 to December 1998. In
December 1998, a contract was signed to provide data processing for a nearby
start-up bank. This customer is expected to contribute approximately $40,000 in
fees during 1999. Montgomery Data is not aggressively marketing this service and
has no other prospective customers at this time.
Noninterest income not classified as "core" by the Company in 1996 was
primarily comprised of $248,000 for data processing fees related to the
nonaffiliated customer noted above and a net gain of $211,000 that the Company
realized from a sale of a branch premises and its related deposits.
Noninterest Expenses
Noninterest expenses for 1998 were $15,912,000, a 12.9% increase over the
$14,088,000 recorded in 1997. The 1997 amount was 7.4% higher than the
$13,113,000 incurred in 1996.
The increases in noninterest expenses in the past two years occurred in
almost all categories and were due primarily to the Company's growth. The
Company incurred higher expenses in order to properly process, manage, and
service the 61% increase in loans and 48% increase in deposits that have
occurred over the past two years. In addition, the Company's branch network grew
from 30 to 36 branches from January 1, 1997 through December 1998 (the Wagram
office was consolidated with the Laurinburg office on December 31, 1998
resulting in 35 remaining branches). Personnel expense, the single largest
component of noninterest expense, increased 15.3% during 1998 and 12.3% during
1997. These increases were primarily due to additional employees associated with
the Company's growth, as well as normal annual wage increases. The total number
of employees of the Company increased 8% in 1998 and 10% in 1997.
The Company has announced plans to open a new branch in Angier, NC, in the
first quarter of 1999. In addition, the Company has announced plans to close two
branches by consolidating them with other branches in the same towns. The
effects of the net reduction in branches by one is not expected to have a
significant impact on the Company's overall noninterest expense.
Table 5 presents the components of the Company's noninterest expense during
the past three years.
Income Taxes
The provision for income taxes was $3,059,000 in 1998, $2,549,000 in 1997,
and $2,213,000 in 1996. The 20% increase in tax expense in 1998 compared to 1997
is a result of a 16% increase in pretax income, as well as an increase in the
Company's effective tax rate from 33.71% in 1997 to 34.99% in 1998. The increase
in the Company's effective tax rate occurred as a result of the Company deriving
a smaller percentage of its earnings from tax-exempt securities. The 15%
increase in taxes when comparing 1997 to 1996 was due entirely to the Company's
15% increase in pretax income, as the Company's effective tax rate remained
constant.
Table 6 presents the components of tax expense and the related effective
tax rates.
ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION
The following discussion focuses on the factors considered by management to
be important in assessing the Company's financial condition. The Company's
assets and deposits continued strong growth rates that began in 1997, reflecting
growth in existing markets and expansion into new geographic areas. As
previously noted, over the past two years, the Company's loans have grown by 61%
and deposits have grown by 48%.
Total assets were $491.8 million at December 31, 1998, an increase of 22.1%
over December 31, 1997. Assets during 1997 grew to $402.7 million at year end, a
20.0% increase over the $335.5 million at December 31, 1996. Interest-earning
assets amounted to $454.9 million at December 31, 1998, a 23.3% increase over
the amount at December 31, 1997. Interest-earning assets at December 31, 1997
were $369.0 million, an increase of 20.7% over the $305.7 million held at
December 31, 1996. Loans, the primary interest-earning asset, grew 27.7% in 1998
and 25.8% in 1997, with a total of $358.3 million at December 31, 1998.
Funding the 1998 and 1997 asset growth were increases in deposits. Deposits
increased 21.9%, or $79.0 million, during 1998, amounting to $440.3 million at
year end. In 1997, deposits grew 21.3%, or $63.4 million, to $361.2 million at
year end. Approximately $14 million of the 1997 asset and deposit growth can be
attributed to a fourth quarter 1997 purchase of a First Union National Bank
branch located in Lillington, N.C.
The Company's assets and deposits have experienced compound annual growth
rates of approximately 14% over the last five years.
Distribution of Assets and Liabilities
Table 7 sets forth the percentage relationships of significant components
of the Company's balance sheets at December 31, 1998, 1997, and 1996. The most
significant variance in this table is the shift in asset mix over the past two
years from securities to loans that is primarily due to strong loan growth that
was partially funded with proceeds from securities maturities and sales.
Securities
Information regarding the Company's securities portfolio as of December 31,
1998, 1997, and 1996 is presented in Tables 8 and 9. Total securities available
for sale and held to maturity amounted to $77.3 million, $71.1 million, and
$76.3 million at December 31, 1998, 1997, and 1996, respectively. The increase
in securities at December 31, 1998 compared to December 31, 1997 is largely due
to the Company purchasing approximately $19 million in securities during the
fourth quarter of 1998. Until the fourth quarter of 1998, because of the
relatively flat yield curve, the Company maintained its excess cash in overnight
investments. With the steepening of the yield curve that occurred with the three
successive 25 basis point rate cuts by the Federal Reserve beginning in early
October, management of the Company purchased securities to realize the higher
yield that could be obtained from securities versus overnight investments.
The decrease in year end securities at December 31, 1997 as compared to
1996 was due to the Company investing more funds in overnight cash investments
at year end to fund the strong loan demand experienced by the Company near year
end, as well as the lack of yield incentive to invest in securities with
maturities longer than overnight due to the flattening of the yield curve that
occurred near that time. Average total securities were approximately $65.0
million during 1998 compared to $75.7 million during 1997 and $69.7 million in
1996. The lower average balance in securities during 1998 was due to the Company
holding more cash in overnight investments versus investing in securities for
most of the year for the reasons discussed above. The increase in the average
balance of securities during 1997 was due to a higher level of funds provided by
the slightly higher growth in the amount of average deposits during the year
versus average loans, as well as funds provided by earnings of the Company.
The composition of the securities portfolios at December 31, 1998, 1997,
and 1996 reflects a shift in 1998 and 1997 from U.S. Treasuries and Government
Agencies to higher yielding mortgage-backed securities, including collateralized
mortgage obligations. Included in mortgage-backed securities at December 31,
1998 were collateralized mortgage obligations with an amortized cost of
$16,656,000 and a fair value of $16,620,000. Included in mortgage-backed
securities at December 31, 1997 were collateralized mortgage obligations with an
amortized cost of $5,157,000 and a fair value of $5,208,000.
.
At December 31, 1998, net unrealized gains of $60,000 were included in the
carrying value of securities classified as available for sale compared to net
unrealized gains of $282,000 at December 31, 1997 and $221,000 at December 31,
1996. Management evaluated any unrealized losses on individual securities at
each year end and determined them to be of a temporary nature and caused by
fluctuations in market interest rates, not by concerns about the ability of the
issuers to meet their obligations. Net unrealized gains, net of applicable
deferred income taxes, of $37,000, $186,000, and $146,000, have been reported as
a separate component of shareholders' equity as of December 31, 1998, 1997, and
1996, respectively.
The fair value of securities held to maturity, which the Company carries at
amortized cost, exceeded their carrying value by $743,000 at December 31, 1998,
$656,000 at December 31, 1997, and $394,000 in 1996. Management evaluated any
unrealized losses on individual securities at each year end and determined them
to be of a temporary nature and caused by fluctuations in market interest rates,
not by concerns about the ability of the issuers to meet their obligations.
Table 9 provides detail as to scheduled contractual maturities and book
yields on securities available for sale and securities held to maturity at
December 31, 1998. Mortgage-backed securities are shown in the time periods
consistent with their estimated life based on expected prepayment speeds.
Approximately 66% of the available for sale portfolio has a maturity date within
5 years. The weighted average life of the available for sale portfolio using the
maturity date for non-mortgage-backed securities, and the expected life for
mortgage-backed securities was 4.1 years. If above-market callable bonds are
assumed to be called at their call date, the average expected life of the
available for sale portfolio drops to 3.1 years. The weighted average
taxable-equivalent yield for the securities available for sale portfolio was
5.93% at December 31, 1998.
The weighted average life of the securities held to maturity portfolio
based on maturity dates was 5.4 years at December 31, 1998 with a weighted
average taxable-equivalent yield of 8.04%. If above-market callable bonds are
assumed to be called on their call date, the weighted average maturity of the
held to maturity portfolio drops to 4.0 years.
As of December 31, 1998 and 1997, the Company held no investment securities
of any one issuer, other than U.S. Treasury and U.S. Government agencies or
corporations, in which aggregate book values and market values exceeded 10% of
shareholders' equity. Other than the collateralized mortgage obligations
previously discussed, the Company owned no securities considered by regulatory
authorities to be derivative instruments.
Loans
Table 10 provides a summary of the loan portfolio composition at each of
the past five year ends.
Loans increased by $77.8 million, or 27.7%, in 1998 to $358.3 million from
the $280.5 million held at December 31, 1997. The 1997 year end amount was $57.5
million, or 25.8%, higher than the $223.0 million balance at December 31, 1996.
The majority of the 1998 loan growth occurred in loans secured by real
estate, with approximately $69.1 million, or 89%, of the net 1998 loan growth
occurring in real estate mortgage or real estate construction loans. In 1998,
real estate mortgage loans grew 27.9%, real estate construction loans grew
89.2%, commercial, financial, and agricultural (CF&A) loans grew 15.4%, and
installment loans to individuals grew 5.6%. For four out of the past five years,
CF&A loans have comprised a lower percentage of the loan portfolio, and for five
straight years, installment loans to individuals have decreased in relation to
the overall portfolio. This shift from non-real estate to real estate loans has
been partially due to a strategic shift towards higher dollar loans, which tend
to be secured by real estate in most cases, in order to more quickly leverage
the Bank's balance sheet and extensive branch network. As noted earlier, the
shift to a higher percentage of real estate loans has contributed to the
decrease in the Bank's loan yields and net interest margin, as real estate loans
generally carry lower interest rates than non-real estate loans.
The loan growth in 1997 was also concentrated in real estate loans, with
real estate loans comprising 73% of the new loan growth. In 1997, real estate
mortgage loans grew 25.1%, real estate construction loans grew 33.3%, CF&A loans
grew 37.2%, and installment loans to individuals grew 11.6%.
A large portion of the Company's loan portfolio has historically been
comprised of loans secured by various types of real estate. At December 31,
1998, $274.4 million or 76.5% of the Company's loan portfolio was secured by
liens on real property. Included in this total are $134.4 million, or 37.5% of
total loans, in credit secured by liens on 1-4 family residential properties and
$140.0 million, or 39.0% of total loans, in credit secured by liens on other
types of real estate.
Table 11 provides a summary of scheduled loan maturities over certain time
periods, with fixed rate loans and adjustable rate loans shown separately.
Approximately 33% of the Bank's loans outstanding at December 31, 1998 mature
within one year and 82% of total loans mature within five years. These
percentages are approximately the same as they were at December 31, 1997. The
percentages of variable rate loans and fixed rate loans to total performing
loans were 46.5% and 53.5% as of December 31, 1998 compared to 51.9% and 48.1%,
respectively, as of December 31, 1997. The bank intentionally makes a blend of
fixed and variable rate loans so as to reduce interest rate risk. The yield on
performing loans as of December 31, 1998 was 8.63% compared to 9.23% at December
31, 1997 and 9.17% at December 31, 1996. The decrease in the yield at December
31, 1998 is primarily due to a 75 basis point lower prime rate when compared to
a year earlier. The slight increase in yield at December 31, 1997 was primarily
a result of a higher prime rate in effect at year end. Both years were affected
by the Company's general trend, beginning in the second half of 1997, of
originating larger balance real estate loans with slightly lower yields.
See additional information regarding interest rate risk on page 21 in the
section entitled "Interest Rate Risk."
Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans past due 90 or more
days and still accruing interest, restructured loans and foreclosed, repossessed
and idled properties. As a matter of policy the Company places all loans that
are past due 90 or more days on nonaccrual basis, and thus there were no such
loans at any of the past five year ends that were 90 days past due and still
accruing interest. Table 12 summarizes the Company's nonperforming assets at the
dates indicated.
Nonaccrual loans are loans on which interest income is no longer being
recognized or accrued because management has determined that the collection of
interest is doubtful. The placing of loans on nonaccrual status negatively
impacts earnings because (i) interest accrued but unpaid as of the date a loan
is placed on nonaccrual status is either deducted from interest income or is
charged-off, (ii) future accruals of interest income are not recognized until it
becomes highly probable that both principal and interest will be paid and (iii)
principal charged-off, if appropriate, may necessitate additional provisions for
loan losses that are charged against earnings. In some cases, where borrowers
are experiencing financial difficulties, loans may be restructured to provide
terms significantly different from the originally contracted terms.
Nonperforming loans (which includes nonaccrual loans and restructured
loans) as of December 31, 1998, 1997 and 1996 totaled $849,000, $1,283,000, and
$2,186,000, respectively. Nonperforming loans as a percentage of total loans
amounted to 0.24%, 0.46%, and 0.98%, at December 31, 1998, 1997, and 1996,
respectively. The decrease in nonperforming loans from 1997 to 1998 is primarily
due to improved overall loan quality, as well as the pay-out of a $230,000 loan
in the first quarter of 1998 that was on nonaccrual status at December 31, 1997.
The decrease in nonperforming loans at December 31, 1997 as compared to December
31, 1996 is primarily attributable to the resolution of several relationships
that resulted in partial charge-offs during the year, as well as generally
improved loan quality. The increase in nonperforming loans at December 31, 1996
compared to December 31, 1995 was largely due to $1,300,000 more in loans on
nonaccrual status that were assumed in corporate acquisitions occurring in 1994
and 1995. These nonaccrual loans that were originated by other institutions
amounted to $1,461,000 at December 31, 1996 compared to $161,000 at December 31,
1995. As of December 31, 1998, the largest nonaccrual balance to any one
borrower was $220,000, with the average balance for the 29 nonaccrual loans
being approximately $21,000.
If the nonaccrual loans and restructured loans as of December 31, 1998, 1997
and 1996 had been current in accordance with their original terms and had been
outstanding throughout the period (or since origination if held for part of the
period), gross interest income in the amounts of approximately $60,000, $91,000
and $183,000 for nonaccrual loans and $25,000, $34,000 and $41,000 for
restructured loans would have been recorded for 1998, 1997 and 1996,
respectively. Interest income on such loans that was actually collected and
included in net income in 1998, 1997 and 1996 amounted to approximately $22,000,
$32,000 and $81,000 for nonaccrual loans (prior to their being placed on
nonaccrual status) and $24,000, $25,000 and $30,000 for restructured loans,
respectively.
In addition to the nonperforming loan amounts included above, management
believes that an estimated $1,200,000-$1,400,000 of loans that are currently
performing in accordance with their contractual terms may potentially develop
problems depending upon the particular financial situations of the borrowers and
economic conditions in general. Management has taken these potential problem
loans into consideration when evaluating the adequacy of the allowance for loan
losses at December 31, 1998 (see discussion below).
Loans classified for regulatory purposes as loss, doubtful, substandard, or
special mention that have not been disclosed in the problem loan amounts and the
potential problem loan amounts discussed above do not represent or result from
trends or uncertainties which management reasonably expects will materially
impact future operating results, liquidity, or capital resources, or represent
material credits about which management is aware of any information which causes
management to have serious doubts as to the ability of such borrowers to comply
with the loan repayment terms.
Foreclosed, repossessed, and idled properties have changed only slightly in
total amount over the past two years, amounting to $505,000 at December 31, 1998
compared to $560,000 at December 31, 1997, and $572,000 at December 31, 1996.
Foreclosed, repossessed, and idled properties represented 0.10%, 0.14%, and
0.17% of total assets at the end of 1998, 1997, and 1996, respectively. The
Company's management has reviewed recent appraisals of these properties and
believes that their fair values, less estimated costs to sell, exceed the
respective carrying values at the dates presented.
Allowance for Loan Losses and Loan Loss Experience
The allowance for loan losses is created by direct charges to operations.
Losses on loans are charged against the allowance in the period in which such
loans, in management's opinion, become uncollectible. The recoveries realized
during the period are credited to this allowance.
The factors that influence management's judgment in determining the amount
charged to operating expense include past loan loss experience, composition of
the loan portfolio, evaluation of possible future losses and current economic
conditions.
The Bank uses a loan analysis and grading program to facilitate its
evaluation of possible future loan losses and the adequacy of its allowance for
loan losses. In this program, risk grades are assigned by management and tested
by the Bank's Internal Audit Department and an independent third party
consulting firm. The testing program includes an evaluation of a sample of new
loans, loans that management identifies as having potential credit weaknesses,
loans past due 90 days or more, nonaccrual loans and any other loans identified
during previous regulatory and other examinations.
The Company strives to maintain its loan portfolio in accordance with what
management believes are conservative loan underwriting policies that result in
loans specifically tailored to the needs of the Company's market areas. Every
effort is made to identify and minimize the credit risks associated with such
lending strategies. The Company has no foreign loans, few agricultural loans and
does not engage in significant lease financing or highly leveraged transactions.
Commercial loans are diversified among a variety of industries. The majority of
loans captioned in the tables discussed below as "real estate" loans are
primarily various personal and commercial loans where real estate provides
additional security for the loan. Collateral for virtually all of these loans is
located within the Company's principal market area.
The allowance for loan losses amounted to $5,504,000 at December 31, 1998
compared to $4,779,000 as of December 31, 1997 and $4,726,000 at December 31,
1996. This represented 1.54%, 1.70%, and 2.12%, of loans outstanding as of
December 31, 1998, 1997, and 1996, respectively. The allowance for loan losses
as a percentage of total loans has been gradually decreasing since its high of
2.81% at September 30, 1994. The September 30, 1994 high of 2.81% was an
increase from the 1.79% ratio at June 30, 1994 due primarily to an addition to
the allowance of $2.5 million that was recorded in the third quarter of 1994 in
connection with a corporate acquisition in which a higher risk loan portfolio
was acquired. The general decrease in the ratio of allowance for loan losses to
total loans since then has been largely due to charge-offs associated with that
portfolio, strong recent loan growth, as well as generally improved overall loan
quality. As noted in Table 12, the Company's allowance for loan losses as a
percentage of nonperforming loans amounted to 648.29% at December 31, 1998
compared to 372.49% at December 31, 1997 and 216.19% at December 31, 1996.
Table 13 sets forth the allocation of the allowance for loan losses at the
dates indicated. The portion of these reserves that was allocated to specific
loan types in the loan portfolio increased from $3,789,000 at December 31, 1997
to $4,220,000 at December 31, 1998. This increase was due to growth in the
Company's loan portfolio, as the Company reserves a minimum percentage for all
loans outstanding. The allocated allowance decreased in 1997 to $3,789,000 from
$4,104,000 at December 31, 1996. This decrease was due to significant
improvement in the Company's loan quality, which was partially offset by the
effects of the minimum reserve percentage on the Company's high 1997 loan
growth. In addition to the allocated portion of the allowance for loan losses,
the Company maintains an unallocated portion that is not assigned to any
specific category of loans, but rather is intended to reserve for the inherent
risk in the overall portfolio and the intrinsic inaccuracies associated with the
estimation of the allowance for loan losses and its allocation to specific loan
categories. The general increase in the unallocated portion of the allowance for
loan losses has been consistent with overall loan growth.
Management considers the allowance for loan losses adequate to cover
possible loan losses on the loans outstanding as of each reporting date. It must
by emphasized, however, that the determination of the allowance using the
Company's procedures and methods rests upon various judgments and assumptions
about future economic conditions and other factors affecting loans. No assurance
can be given that the Company will not in any particular period sustain loan
losses that are sizable in relation to the amount reserved or that subsequent
evaluations of the loan portfolio, in light of conditions and factors then
prevailing, will not require significant changes in the allowance for loan
losses or future charges to earnings.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowances for loan losses and
losses on foreclosed real estate. Such agencies may require the Bank to
recognize additions to the allowances based on the examiners' judgments about
information available to them at the time of their examinations.
For the years indicated, Table 14 summarizes the Company's balances of
loans outstanding, average loans outstanding, changes in the allowance arising
from charge-offs and recoveries by category, and additions to the allowance that
have been charged to expense. The Company's net loan charge offs were
approximately $265,000 in 1998, $522,000 in 1997, and $186,000 in 1996. This
represents 0.08%, 0.21%, and 0.09% of average loans during 1998, 1997, and 1996,
respectively. In the current economic environment, the Company generally
projects annual net charge-offs to average loans of approximately 0.20% to
0.30%. For the year ended 1996, several large recoveries were primarily
responsible for the low 0.09% net charge-off percentage. For 1998, unusually low
gross charge-offs of $434,000 were primarily responsible for the low net
charge-off percentage of 0.08%. Charge-offs in 1995 included approximately
$590,000 of loans related to the parties involved in a litigation matter that
was settled on December 28, 1995.
Deposits
The average amounts of deposits of the Company for the years ended December
31, 1998, 1997 and 1996 are presented in Table 15. Average deposits grew $76.3
million, or 23.8%, during 1998 to $397.0 million. Average deposits for 1997 grew
by 10.4% over the 1996 average to $320.7 million.
The $44.8 million in growth in the two time deposit categories accounted
for 58.7% of the 1998 growth, with average time deposits greater than $100,000
increasing by $17.0 million, or 48.6%, during the year and average other time
deposits growing by $27.9 million, or 23.4%. The increase in time deposits
during 1998 was due to expansion of the Company's customer base, as well as the
Company more competitively pricing time deposits in order to help fund the
strong loan growth. Despite the slightly lower interest rate environment during
1998, this more competitive pricing increased the average rate that the Company
paid on time deposits greater than $100,000 from 5.75% in 1997 to 5.91% in 1998,
and increased the average rate that the Company paid on other time deposits from
5.28% in 1997 to 5.34% in 1998. While time deposits experienced the highest
growth rates, the growth rates of the other deposit categories were also strong,
with average interest-bearing demand deposits growing by 17.4%, average savings
deposits growing by 19.9%, and average non-interest bearing deposits growing by
21.1%. The four basis point decrease in the average rate paid on
interest-bearing demand deposits in 1998 can be attributed to reductions in the
rates that the Company paid on these accounts that were made when the prime and
federal funds rates were decreased in the last quarter of the year. The five
basis point increase in the average rate paid on savings deposits is largely a
result of most of the growth in this category occurring in the Company's higher
yielding preferred savings sweep account.
The category of deposits with the largest percentage increase during 1997
was interest-bearing demand deposits, which increased by 20.0%. This increase
can be partially attributed to the Company restructuring several of its accounts
within this category to offer more competitive rates. This resulted in a 24
basis point increase in the average rate paid on interest-bearing demand
deposits for the year. For 1997, average savings deposits increased by 2.7%,
average time deposits increased by 8.8%, and average noninterest-bearing
deposits grew by 4.5%, over the averages from 1996.
The Company has a large, stable base of time deposits with little
dependence on volatile public deposits of $100,000 or more. The time deposits
are principally certificates of deposit and individual retirement accounts
obtained from individual customers. Deposits of certain local governments and
municipal entities represented 4.2% of the Bank's total deposits at December 31,
1998. All such public funds are collateralized by investment securities. The
Company does not purchase brokered deposits.
As of December 31, 1997, the Company held approximately $60,720,000 in time
deposits of $100,000 or more and other time deposits of $156,639,000. Table 16
is a maturity schedule of time deposits of $100,000 or more as of December 31,
1998. This table shows that 86.7% of the Company's time deposits greater than
$100,000 mature within one year.
Interest Rate Risk (Including Quantitative and Qualitative Disclosures About
Market Risk - Item 7A.)
Net interest income is the Company's most significant component of
earnings. Notwithstanding changes in volumes of loans and deposits, the
Company's level of net interest income is continually at risk due to the effect
that changes in general market interest rate trends have on interest yields
earned and paid with respect to the various categories of earning assets and
interest-bearing liabilities. It is the Company's policy to maintain portfolios
of earning assets and interest-bearing liabilities with maturities and repricing
opportunities that will afford protection, to the extent practical, against wide
interest rate fluctuations. The Company's exposure to interest rate risk is
analyzed on a regular basis by management using standard GAP reports, maturity
reports, and an asset/liability software model that simulates future levels of
interest income and expense based on current interest rates, expected future
interest rates, and various intervals of "shock" interest rates. Over the years,
the Company has been able to maintain a fairly consistent yield on average
earning assets (net interest margin). Over the past ten years the net interest
margin has not varied in any single year by more than the 41 basis point change
experienced by the Company in 1998, and the lowest net interest margin realized
over that same period is within 60 basis points of the highest. Prior to 1998,
the most that the Company's net interest margin varied from one year to the next
was 20 basis points.
The Company reported a net interest margin of 5.03% in the fourth quarter
of 1998 compared to 5.14% in the third quarter of 1998, 5.30% in the second
quarter of 1998 and 5.55% in the first quarter of 1998. Management believes,
that assuming a relatively static interest rate environment, the net interest
margin should stabilize. At the end of the third quarter of 1998, when changes
in the prime rate began to occur, the Company's interest sensitivity position
was similar to that at December 31, 1998 as illustrated in Table 17. Table 17
illustrates that the Company is more liability sensitive in the "over 3 to 12
month" horizon than in the "3 months or less" horizon. As the effects of the
fourth quarter drop in the prime rate continue to manifest, the Company expects
to have more liabilities repricing at the lower prime-adjusted rate than assets.
The positive effects on net interest income of this scenario are likely to be
offset by continued competitive pricing pressures, as well as securities that
are expected to be called. While the Company can not guarantee stability in the
net interest margin in the future, at this time, management does not expect
significant fluctuations.
See additional discussion of the Company's net interest margin in the "Net
Interest Income" section above.
Table 17 sets forth the Company's interest rate sensitivity analysis as of
December 31, 1998, using stated maturities for all instruments except
mortgage-backed securities which are shown as a lump sum in the period
consistent with their weighted average estimated life. As illustrated by this
table, the Company has $110.7 million more in interest-bearing liabilities that
are subject to interest rate changes within one year than earning assets (this
amount is reduced by approximately $10 million if above-rate callable bonds are
assumed to be called on their call date). This generally would indicate that net
interest income would experience downward pressure in a rising interest rate
environment and would benefit from a declining interest rate environment.
However, this method of analyzing interest sensitivity only measures the
magnitude of the timing differences and does not address earnings, market value,
or management actions. Also, interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates. In
addition to the effects of "when" various rate-sensitive products reprice,
market rate changes may not result in uniform changes in rates among all
products. For example, included in interest-bearing liabilities at December 31,
1998 subject to interest rate changes within one year are deposits totaling
$160.4 million comprised of NOW, savings, and certain types of money market
deposits with interest rates set by management. These types of deposits
historically have not repriced coincidentally with or in the same proportion as
general market indicators. Thus, the Company believes that near term net
interest income would not likely experience significant downward pressure from
rising interest rates. Similarly, management would not expect a significant
increase in near term net interest income from falling interest rates. As of
December 31, 1998, approximately 83% of interest-earning assets could be
repriced within five years and substantially all interest-bearing liabilities
could be repriced within five years.
The Company has no market risk sensitive instruments held for trading
purposes, nor does it maintain any foreign currency positions. Table 18 presents
the expected maturities of the Company's other than trading market risk
sensitive financial instruments. Table 18 also presents the fair values of
market risk sensitive instruments as estimated in accordance with Statement of
Financial Accounting Standards No. 107, "Disclosures About Fair Value of
Financial Instruments." The Company's fixed rate earning assets have estimated
fair values that are slightly higher than their carrying value. This is due to
the yields on these portfolios being slightly higher than market yields at
December 31, 1998 for instruments with maturities similar to the remaining term
of the portfolios due to a generally declining interest rate environment at year
end. The estimated fair value of the Company's time deposits is higher than its
book value for the same reason.
Off-Balance Sheet Risk
In the normal course of business there are various outstanding commitments
and contingent liabilities, such as commitments to extend credit, which are not
reflected in the financial statements. These commitments are not recorded as an
asset or liability until exercised. As of December 31, 1998, the Company had
outstanding loan commitments of $84,383,000, of which $70,851,000 were at
variable rates and $13,532,000 were at fixed rates. Included in outstanding loan
commitments were unfunded commitments of $33,996,000 on revolving credit plans,
of which $29,726,000 were at variable rates and $4,270,000 were at fixed rates.
Additionally, standby letters of credit of approximately $924,000 and $1,108,000
were outstanding at December 31, 1998 and 1997, respectively. The Company's
exposure to credit loss for the aforementioned commitments in the event of
nonperformance by the party to whom credit or financial guarantees have been
extended is represented by the contractual amount of the financial instruments
discussed above. However, management believes that these commitments represent
no more than the normal lending risk that the Company commits to its borrowers.
If these commitments are drawn, the Company plans to obtain collateral if it is
deemed necessary based on management's credit evaluation of the counter-party.
The types of collateral held varies but may include accounts receivable,
inventory and commercial or residential real estate. Management expects any
draws under existing commitments to be funded through normal operations.
Derivative financial instruments include futures, forwards, interest rate
swaps, options contracts, and other financial instruments with similar
characteristics. The Company does not engage in derivatives activities.
Return On Assets And Equity
Table 19 shows return on assets (net income divided by average total
assets), return on equity (net income divided by average shareholders' equity),
dividend payout ratio (dividends declared per share divided by net income per
share) and shareholders' equity to assets ratio (average shareholders' equity
divided by average total assets) for each of the years in the three-year period
ended December 31, 1998.
Liquidity
The Company's liquidity is determined by its ability to convert assets to
cash or acquire alternative sources of funds to meet the needs of its customers
who are withdrawing or borrowing funds, and to maintain required reserve levels,
pay expenses and operate the Company on an ongoing basis. The Company's primary
liquidity sources are net income from operations, cash and due from banks,
federal funds sold and other short-term investments. The Company's securities
portfolio is comprised almost entirely of readily marketable securities which
could also be sold to provide cash. In addition, the Bank has the ability, on a
short-term basis, to purchase $15 million in federal funds from other financial
institutions and has a $50 million line of credit with the Federal Home Loan
Bank (the "FHLB") in place that can provide short or long term financing. The
Company has not historically had to rely on these sources of credit as a source
of liquidity. The Company has experienced an increase in its loan to deposit
ratio over the past two years, from 74.9% at December 31, 1996 to 77.7% at
December 31, 1997 to 81.4% at December 31, 1998, as a result of the significant
loan growth experienced. This strong loan growth has reduced the Company's
liquidity sources. To further enhance available liquidity sources, during 1998
the Company increased its available line of credit with the FHLB from $36
million to $50 million. Beginning in the third quarter of 1998, although the
Company did not have any liquidity or funding difficulties, the Company began
making periodic draws and repayments on this line of credit on an overnight
basis to maintain liquidity ratios at internally targeted levels. At December
31, 1998, the Company had outstanding short-term borrowings totaling $6 million,
while the average amount outstanding for the year was $2.5 million. The
Company's management believes its liquidity sources are at an acceptable level
and remain adequate to meet its operating needs.
Capital Resources
The Company is regulated by the Board of Governors of the Federal Reserve
Board ("FRB") and is subject to securities registration and public reporting
regulations of the Securities and Exchange Commission. The Bank is regulated by
the Federal Deposit Insurance Corporation ("FDIC") and the North Carolina State
Banking Commission. The Company is not aware of any recommendations of
regulatory authorities or otherwise which, if they were to be implemented, would
have a material effect on its liquidity, capital resources, or operations.
The Company and the Bank must comply with regulatory capital requirements
established by the FRB and FDIC. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary, actions
by regulators that, if undertaken, could have a direct material effect on both
the Company's and the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of the Company's and the Bank's assets, liabilities, and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Company's and the Bank's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors. These capital standards require the Company to
maintain minimum ratios of "Tier 1" capital to total risk-weighted assets and
total capital to risk-weighted assets of 4.00% and 8.00%, respectively. Tier 1
capital is comprised of total shareholders' equity calculated in accordance with
generally accepted accounting principles less intangible assets, and total
capital is comprised of Tier 1 capital plus certain adjustments, the largest of
which for the Company is the allowance for loan losses. Risk-weighted assets
refer to the on- and off-balance sheet exposures of the Company adjusted for
their related risk levels using formulas set forth in FRB and FDIC regulations.
In addition to the risk-based capital requirements described above, the
Company is subject to a leverage capital requirement, which calls for a minimum
ratio of Tier 1 capital (as defined above) to quarterly average total assets of
3.00% to 5.00%, depending upon the institution's composite ratings as determined
by its regulators. The FRB has not advised the Company of any requirement
specifically applicable to it.
In addition to the minimum capital requirements described above, the
regulatory framework for prompt corrective action also contains specific capital
guidelines for classification as "well capitalized," which are presented with
the minimum ratios and the Company's ratios at December 31, 1998, 1997 and 1996
in Table 20.
At December 31, 1998, 1997 and 1996, the Company was in compliance with all
existing capital requirements. Although the Company continues to exceed even the
regulatory thresholds for "well capitalized" status, the Company's capital
ratios have been steadily declining with the strong growth the Company has
experienced. The Company's Total Risk-Based Capital to Tier II Risk Adjusted
Assets ratio of 10.75% at December 31, 1998, compared to the "well capitalized"
threshold of 10.00%, is the only one of the three regulatory ratios that is
within 200 basis points of falling below the "well capitalized" threshold. The
Company has plans in place to correct any ratio that falls below the "well
capitalized" threshold.
See "Supervision and Regulation" under "Business" above and note 14 to the
consolidated financial statements for discussion of other matters that may
affect the Company's capital resources.
Year 2000 Issue
The Company recognizes and is addressing the potentially severe
implications of the "Year 2000 Issue." The "Year 2000 Issue" (also known as
"Y2K") is a general term used to describe the various problems that may result
from the improper processing of dates and date-sensitive calculations as the
year 2000 approaches. This issue is caused by the fact that many of the world's
existing computer programs use only two digits to identify the year in the date
field of a program. These programs were designed and developed without
considering the impact of the upcoming change in the century and could
experience serious malfunctions when the last two digits of the year change to
"00" as a result of identifying a year designated "00" as the year 1900 rather
than the year 2000. This misidentification could prevent the Company from being
able to engage in normal business operations, including, among other things,
miscalculating interest accruals and the inability to process customer
transactions. Because of the potentially serious ramifications of the Year 2000
Issue, the Company is taking the Year 2000 Issue very seriously.
The Company's Technology Committee, which is comprised of a cross-section
of the Company's employees, is leading the Company's Year 2000 efforts and
involving all employees of the Company in ensuring that the Company is properly
prepared for the Year 2000. The Company's Board of Directors has approved a plan
submitted by the Technology Committee that was developed in accordance with
guidelines set forth by the Federal Financial Institutions Examination Council.
This plan has three primary phases related to internal Year 2000 compliance.
The first phase of the Company's efforts to address the Year 2000 Issue was
to inventory all known Company processes that could reasonably be expected to be
impacted by the Year 2000 Issue and their related vendors, if applicable. This
inventory of processes and vendors included not only typical computer processes
such as the Company's transaction applications systems, but all known processes
that could be impacted by micro-chip malfunctions. These include but are not
limited to the Company's alarm system, phone system, check ordering process, and
ATM network. This phase is complete, although it is periodically updated as
necessary.
The Company's second phase in addressing the Year 2000 Issue was to contact
all third party vendors, request documentation regarding their Year 2000
compliance efforts, and analyze the responses. This was a significant phase
because the Company does not perform in-house programming, and thus is dependent
on external vendors to ensure and modify, if necessary, the hardware, software,
or service they provide to the Company to be Year 2000 compliant. This phase is
now virtually complete and the Company is currently following up on any issues
or concerns identified in the responses received, as necessary.
The next phase for the Company under the Plan is to complete a
comprehensive testing of all known processes. Under the plan, processes are
initially to be tested on a stand-alone basis and then they are to be tested on
an integrated basis with other processes. Testing of the Company's processes on
a stand-alone basis is substantially complete. Testing on a integrated basis is
scheduled to be complete by May 31, 1999. Management plans for any corrective
actions to be implemented to ensure that the Company is fully prepared for the
year 2000 by the end of the second quarter of 1999. The most significant phase
of testing is the testing of the Company's core software applications. Upgrades
of the core software applications currently used by the Company were received
from the software vendor in June 1998 and were represented to be Year 2000
compliant by the vendor. These applications were successfully loaded onto the
Company's hardware system in July 1998 and Year 2000 testing began in September
1998. The testing of the core applications on a stand-alone basis revealed no
problems and none are expected to be encountered during the integrated testing.
Another part of the Company's Year 2000 plan is to assess the Year 2000
readiness of its significant borrowers and depositors. Through the use of
questionnaires and personal contacts, the Company has gathered information
regarding the Year 2000 readiness of significant borrowers and depositors of the
Company. The assessment of the Company's significant depositors is complete. The
assessment of the Company's significant borrowers is currently in process and is
expected to be complete by the end of the first quarter of 1999. Customers who
the Company has Year 2000 concerns about are being counseled on the Year 2000
Issue, urged to take action, and placed on an internal watch list that will be
updated on a quarterly basis and reviewed and monitored by the Company for any
potential effects on the Company. Based on the evaluation to date, management of
the Company does not believe that the number or magnitude of customers with
potential Year 2000 problems will be significant. Prospective new loan customers
are also assessed for Year 2000 compliance as a part of the underwriting process
of significant loans.
Management is also working closely with outside consultants and the FDIC on
the Company's Year 2000 readiness.
In the Company's 1997 Form 10-K, the Company disclosed an estimated range
of total costs to address the Year 2000 Issue to be from $100,000 to $150,000.
During the second quarter of 1998, management believed that the estimated cost
to modify the Company's automated teller machines (ATMs) would likely be higher
than originally projected. As a result, the Company projected the total costs to
address the Year 2000 Issue to be from $175,000 to $200,000. In the fourth
quarter of 1998, the Company's Year 2000 testing of its existing ATMs was
successful, and now the Company does not believe that there will be any
significant Year 2000 costs associated with the Company's ATMs. Based on an
evaluation of the Company's current Year 2000 status, it is now management's
belief that total Year 2000 costs will be approximately $100,000, which are
being expensed as they occur. In 1998 and to date, the Company expensed
approximately $32,000 in Year 2000 Issue related costs. The majority of the
remainder of the Year 2000 Issue costs are expected to occur in the first half
of 1999. The estimated and actual Year 2000 costs include only direct external
costs associated with Year 2000 readiness, and do not include any amounts
attributable to the significant time that management and the staff of the
Company has spent planning, preparing and testing for Year 2000 readiness.
Although funding of the Year 2000 project costs will come from normal operating
cash flow, the external expenses associated with the Year 2000 Issue will
directly reduce otherwise reported net income for the Company.
Management of the Company believes that the potential effects on the
Company's internal operations of the Year 2000 Issue can and will be addressed
prior to the Year 2000. However, if required modifications or conversions are
not made or are not completed on a timely basis prior to the Year 2000, the Year
2000 Issue could disrupt normal business operations. The most reasonably likely
worst case Year 2000 scenarios foreseeable at this time would include the
Company temporarily not being able to process, in some combination, various
types of customer transactions. This could affect the ability of the Company to,
among other things, originate new loans, post loan payments, accept deposits or
allow immediate withdrawals, and, depending on the amount of time such a
scenario lasted, could have a material adverse effect on the Company. Because of
the serious implications of these scenarios, the primary emphasis of the
Company's Year 2000 efforts is to correct, with complete replacement if
necessary, any systems or processes whose Year 2000 test results are not
satisfactory prior to the year 2000. Nevertheless, should one of the most
reasonably likely worst case scenarios occur in the year 2000, the Company is
currently refining a contingency plan that would allow for limited transactions,
including the ability to make certain deposit withdrawals, until the Year 2000
problems are remediated.
The costs of the Year 2000 project and the date on which the Company plans
to complete Year 2000 compliance are based on management's best estimates, which
were derived using numerous assumptions of future events such as the
availability of certain resources (including internal and external resources),
third party vendor plans and other factors. However, there can be no guarantee
that these estimates will be achieved at the cost disclosed or within the time
frame indicated, and actual results could differ materially from these plans.
Factors that might affect the timely and efficient completion of the Company's
Year 2000 project include, but are not limited to, vendors' abilities to
adequately correct or convert software and the effect on the Company's ability
to test its systems, the availability and cost of personnel trained in the Year
2000 area, the ability to identify and correct all relevant computer programs
and similar uncertainties.
Inflation
Since the assets and liabilities of a bank are primarily monetary in nature
(payable in fixed determinable amounts), the performance of a bank is affected
more by changes in interest rates than by inflation. Interest rates generally
increase as the rate of inflation increases, but the magnitude of the change in
rates may not be the same. The effect of inflation on banks is normally not as
significant as its influence on those businesses that have large investments in
plant and inventories. During periods of high inflation, there are normally
corresponding increases in the money supply, and banks will normally experience
above average growth in assets, loans and deposits. Also, general increases in
the price of goods and services will result in increased operating expenses.
Accounting Changes
The Company prepares its financial statements and related disclosures in
conformity with standards established by, among others, the Financial Accounting
Standards Board (the "FASB"). Because the information needed by users of
financial reports is dynamic, the FASB frequently issues new rules and proposed
new rules for companies to apply in reporting their activities. During 1998, the
Company adopted three new accounting standards: Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income", SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information" and
SFAS No. 132, "Employers Disclosures about Pensions and Other Postretirement
Benefits." None of the three standards adopted in 1998 changed the way Company
measures its assets, liabilities, income or expense. The three standards adopted
in 1998 are discussed below.
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" which established standards for reporting and display of
comprehensive income and its components in a full set of financial statements.
Comprehensive income is defined as the change in equity during a period for
non-owner transactions and is divided into net income and other comprehensive
income. Other comprehensive income includes revenues, expenses, gains, and
losses that are excluded from earnings under current accounting standards. This
statement does not change or modify the reporting or display in the income
statement. SFAS No. 130 was effective for interim and annual periods beginning
after December 15, 1997. Comparative financial statements for earlier periods
have been presented to reflect the application of this statement.
The FASB has issued Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information." The
statement requires management to report selected financial and descriptive
information about reportable operating segments. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. Generally, disclosures are required for segments internally
identified to evaluate performance and resource allocation. SFAS No. 131 was
effective for financial statements for periods beginning after December 15,
1997. In all material respects, the Company's operations are entirely within the
commercial banking segment, and the information presented herein reflects the
results of that segment.
On January 1, 1998, the Company adopted SFAS No. 132, "Employers
Disclosures about Pensions and Other Postretirement Benefits." This statement
standardized the disclosure requirements of pensions and other postretirement
benefits. This statement did not change any measurement or recognition
provisions, and thus did not materially impact the Company. The Company has two
defined benefit plans that were subject to the disclosures required by this
statement. See the required disclosures in note 10 to the consolidated financial
statements.
The Financial Accounting Standards Board has also issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This Statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. This
Statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Because the Company has not historically and does not currently
employ the use of derivatives, this Statement is not expected to impact the
Company.
In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
affected the way the Company measured and presented its earnings per share
information.
The Company adopted SFAS No. 128, "Earnings Per Share" (SFAS No. 128) as of
December 31, 1997. SFAS No. 128 superseded Accounting Principles Board Opinion
No. 15, "Earnings Per Share" (APB No. 15) which the Company had followed until
the adoption of SFAS No. 128. For companies that have potentially issuable stock
(complex capital structures), such as First Bancorp with its stock option plan,
SFAS No. 128 requires that two earnings per share amounts be disclosed - 1)
Basic Earnings Per Share and 2) Diluted Earnings Per Share. Basic Earnings Per
Share is calculated by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted Earnings Per Share is
computed by assuming the issuance of common shares for all dilutive potential
common shares outstanding during the reporting period. Currently, the Company's
only dilutive potential common stock issuances relate to options that have been
issued under the Company's stock option plan- see note 13 to the consolidated
financial statements for additional information regarding the stock option plan.
In computing Diluted Earnings Per Share, it is assumed that all such dilutive
stock options are exercised during the reporting period at their respective
exercise prices, with the proceeds from the exercises used by the Company to buy
back stock in the open market at the average market price in effect during the
reporting period. The difference between the number of shares assumed to be
exercised and the number of shares bought back is added to the number of
weighted average common shares outstanding during the period. The sum is used as
the denominator to calculate Diluted Earnings Per Share for the Company.
FORWARD-LOOKING STATEMENTS
The foregoing discussion may contain statements that could be deemed
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934 and the Private Securities Litigation Reform Act, which
statements are inherently subject to risks and uncertainties. Forward-looking
statements are statements that include projections, predictions, expectations or
beliefs about future events or results or otherwise are not statements of
historical fact. Such statements are often characterized by the use of
qualifying words (and their derivatives) such as "expect," "believe,"
"estimate," "plan," "project," or other statements concerning opinions or
judgment of the Company and its management about future events. Factors that
could influence the accuracy of such forward-looking statements include, but are
not limited to, the financial success or changing strategies of the Company's
customers, actions of government regulators, the level of market interest rates,
and general economic conditions.
Table 1 Selected Consolidated Financial Data
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, Five-Year
($ in thousands except per share Compound
and nonfinancial data) 1998 1997 1996 1995 1994 Growth
-------- ------ ------ ------ ------ ----
Income Statement Data
Interest income $ 35,344 29,197 25,468 23,106 18,873 15.1%
Interest expense 14,356 11,123 9,916 8,953 6,257 18.8%
Net interest income 20,988 18,074 15,552 14,153 12,616 12.8%
Provision for loan losses 990 575 325 900 387 10.9%
Net interest income after provision 19,998 17,499 15,227 13,253 12,229 12.9%
Noninterest income 4,656 4,150 4,446 3,777 3,293 10.7%
Noninterest expense 15,912 14,088 13,113 14,868 11,380 9.8%
Income before income taxes 8,742 7,561 6,560 2,162 4,142 18.6%
Income taxes 3,059 2,549 2,213 580 1,155 24.5%
Net income 5,683 5,012 4,347 1,582 2,987 16.0%
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Per Share Data
Earnings - basic $ 1.88 1.66 1.44 0.53 0.99 15.9%
Earnings - diluted 1.83 1.62 1.43 0.52 0.99 15.3%
Cash dividends declared 0.60 0.52 0.44 0.35 0.33 15.7%
Dividend payout per basic share 31.91% 31.33% 30.56% 66.04% 33.33% -0.2%
Market Price
High $ 42.00 35.00 19.50 14.75 11.50 32.0%
Low 24.00 18.50 11.50 10.25 9.00 26.6%
Close 29.00 35.00 18.50 12.75 10.50 22.5%
Stated book value 13.40 12.17 11.02 10.04 9.57 8.0%
Tangible book value 11.47 10.02 9.08 7.95 7.48 5.8%
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Selected Balance Sheet Data (at year end)
Securities $ 77,280 71,133 76,265 69,397 67,092 3.3%
Loans 358,334 280,513 223,032 211,522 185,749 17.9%
Allowance for loan losses 5,504 4,779 4,726 4,587 5,009 14.5%
Intangible assets 5,843 6,487 5,834 6,306 6,279 33.6%
Total assets 491,838 402,669 335,450 321,739 289,613 13.8%
Deposits 440,266 361,224 297,861 287,715 258,430 14.2%
Total shareholders' equity 40,494 36,765 33,232 30,277 28,790 8.1%
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Selected Average Balances
Assets $ 443,214 359,879 326,221 296,400 267,227 12.3%
Loans 325,477 245,596 217,900 192,035 168,167 16.9%
Earning assets 412,858 333,029 298,308 269,313 244,708 12.8%
Deposits 396,987 320,659 290,510 262,846 236,725 12.7%
Interest-bearing liabilities 345,528 276,148 247,883 225,006 204,141 12.2%
Shareholders' equity 38,946 35,024 31,896 30,461 28,197 7.8%
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Year Ended December 31, Five-Year
($ in thousands except per share Compound
and nonfinancial data) 1998 1997 1996 1995 1994 Growth
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Ratios
Return on average equity 14.59% 14.31% 13.63% 5.19% 10.59%
Return on average assets 1.28% 1.39% 1.33% 0.53% 1.12%
Net interest margin (taxable-equivalent basis) 5.24% 5.65% 5.45% 5.50% 5.41%
Averag