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U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to _____________
Commission file number 0-13086
FNB FINANCIAL SERVICES CORPORATION
202 South Main Street
Reidsville, North Carolina 27320
(336) 342-3346
Incorporated in the State of North Carolina
IRS Employer Identification No. 56-1382275
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT:
None
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SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, Par Value $1.00 Per Share
---------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers in response
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
The aggregate market value of the registrant's Common Stock at March
10, 2000 held by those persons deemed by the registrant to be non-affiliates,
based on the average bid and asked price of the Common Stock on that day, was
approximately $50.1 million.
As of March 10, 2000 (the most recent practicable date), the
registrant had outstanding 4,484,173 shares of Common Stock, $1.00 par value.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
- -------- ------------------
1. Proxy Statement for the Annual Meeting of Shareholders Part III
to be held May 18, 2000, to be mailed to shareholders
within 120 days of December 31, 1999.
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FORM 10-K TABLE OF CONTENTS
INDEX
PAGE
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PART I
Item 1. Business........................................................ 1
Item 2. Properties...................................................... 21
Item 3. Legal Proceedings............................................... 22
Item 4. Submission of Matters To a Vote of Security Holders............. 22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................... 23
Item 6. Selected Financial Data......................................... 23
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...... 32
Item 8. Financial Statements and Supplementary Data..................... 42
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 69
PART III
Item 10. Directors and Executive Officers of the Registrant.............. 69
Item 11. Executive Compensation.......................................... 69
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 69
Item 13. Certain Relationships and Related Transactions.................. 69
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K..................................................... 70
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PART I
ITEM 1. BUSINESS
GENERAL
FNB Financial Services Corporation (the "Company") is a North Carolina
bank holding company with consolidated assets of $588 million, deposits of $484
million and shareholders' equity of $51 million, each as of December 31, 1999.
The Company was organized in 1984, although its predecessor and wholly-owned
subsidiary, FNB Southeast, opened as Rockingham Savings Bank and Trust in 1910,
then was chartered as a national bank in 1918 under the name of First National
Bank of Reidsville. Effective March 15, 1999, FNB Southeast changed its charter
from a national bank to a North Carolina state bank. In addition, on August 31,
1999, the Company acquired Black Diamond Savings Bank, a federal savings bank
headquartered in Norton, Virginia. Historically, the Company has served the
Rockingham County area of North Carolina through three branches in Reidsville
and two in Eden, North Carolina. In 1995, the Company initiated a strategic
growth plan beginning with the hiring of a new chief executive officer. By the
end of 1999, FNB Southeast increased its number of branches from five to ten by
closing a branch in Eden and opening new branches in the Rockingham County towns
of Eden, Ruffin and Madison and in the new markets of Greensboro, Burgaw and
Wilmington, North Carolina. The acquisition of Black Diamond added five branches
in Norton, Harrisonburg, Pennington Gap, and Richlands, Virginia. As of, and for
the twelve months ended December 31, 1994, the Company reported net interest
income, loans and deposits of $6.6 million, $79.8 million and $132.5 million,
respectively. As a result of its strategy, at December 31, 1999, the Company
reported net interest income of $20.4 million, loans of $413.3 million and
deposits of $484.2 million.
The Company's subsidiary banks are community oriented and focus
primarily on offering commercial, real estate and consumer loans, and deposit
and other financial services to individuals, small to medium-sized businesses
and other organizations in its market areas. The Company emphasizes its
individualized services and community involvement, while at the same time
providing its customers with the financial sophistication and array of products
typically offered by larger banks. The Company competes successfully with larger
banks located within and outside of North Carolina and Virginia by retaining its
personalized approach and community focus.
Under the leadership of Ernest J. Sewell, who became President and
Chief Executive Officer in January 1995, the Company adopted the following
three-part strategy: (1) increase market share and geographic reach through
opportunistic acquisitions in markets where the mix of economic, operational,
cultural and other factors are favorable; (2) position the Company to manage its
planned growth by adding experienced personnel and upgrading its internal
systems and procedures; and (3) generate internal growth at its existing banking
offices by offering new and complementary services and products. To accomplish
these objectives, during the past five years the Company has: (a) increased the
number of its branch offices to ten by opening new offices in Eden, Ruffin,
Madison, Greensboro, Burgaw, and Wilmington, North Carolina; (b) expanded by
approximately 60% the number of its full-time personnel by adding 54 new
employees, including several new vice presidents and senior vice presidents; (c)
completed the merger with Black Diamond to extend the Company's reach into
Virginia in the Norton, Virginia region, where Black Diamond has a very strong
market presence and in the Harrisonburg, Virginia market; (d) completed a
systematic review and revision of its loan administration, loan policy and
credit procedures; and (e) enhanced its mix of products and services by
broadening the scope of its commercial lending activities and by updating and
extending its ATM terminals and network.
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The Company plans to continue to pursue these objectives by
strengthening its presence in existing markets and opportunistically reaching
into new markets in North Carolina, Virginia and South Carolina. The Company
will seek to hire qualified personnel to help manage its planned growth and to
develop new products that are uniquely consistent with the Company's service
orientation. The Company also plans, where appropriate, to upgrade its systems
and procedures and refine its ability to offer customers sophisticated services
without sacrificing its personalized approach.
STRATEGY
Expand Banking Operations. Throughout most of its 90-year history, the
Company's banking activities were centered in Reidsville, North Carolina,
located in Rockingham County in the north central part of the State. Beginning
in 1995, however, the Company initiated a growth strategy to further penetrate
markets in which it had an existing market share and expand into and develop new
and contiguous markets, such as Wilmington and Greensboro, North Carolina and
Virginia. Management selects its target markets based on a number of factors,
including market size and growth potential, banking relationships developed by
members of management during their careers and the ability to integrate the
targeted market into the Company's community oriented culture.
The Company's expansion strategy, both within and outside of its
existing markets, involves three key elements: (i) install high-quality,
well-trained management to serve the market; (ii) ascertain that the market is
underserved by financial institutions whose primary focus is to cater to the
individualized needs of customers; and (iii) find reasonably priced facilities.
Management believes that it has been successful in implementing these strategic
elements in its expansion program to date.
The Company has acquired two parcels of property in Greensboro, North
Carolina and expects to open two branches in early second quarter 2000. The
Company leases a branch in Burgaw, North Carolina and opened this branch in
December, 1999. The eastern North Carolina town of Burgaw is contiguous to the
Wilmington market, and the Company currently has one branch in Greensboro.
In August, 1999 the Company merged with Black Diamond and acquired
offices in Norton, Harrisonburg, Pennington Gap and Richlands, Virginia. These
branches serve the market areas of Wise, Tazewell, Russell, Lee, Rockingham and
Augusta Counties in Virginia.
Seize Market Expansion Opportunities. The Company intends to continue
to capitalize on opportunities to enter new and contiguous markets which it
believes are underserved as a result of banking consolidation and in which the
Company's community oriented philosophy and culture would flourish. The Company
believes that there is value to be added by providing the opportunity for
greater personalized banking relationships than exist with larger commercial
banks in its markets, although the Company also recognizes the need to carefully
analyze markets that are already well served by numerous institutions. The
Company will continue to distinguish itself by emphasizing high quality,
sophisticated services in a hometown environment.
Establish a Platform for Future Growth. The Company seeks to position
itself to manage its future expected growth in two fundamental ways: (1)
attract, retain and reward experienced personnel who are committed both to
conducting business in a friendly and personable manner and to the communities
in which they work and live; and (2) finalize a program to upgrade, modify and
expand its internal systems, procedures, equipment and software designed to
improve marketing and operating efficiencies. The Company will also continue to
analyze technological developments in the banking industry for opportunities to
improve or augment its services and products, although management will make
every effort to maintain the Company's personalized approach as pressures to
succumb to
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technological advances mount. The Company believes that FNB Southeast's change
from a nationally-chartered institution to a state-chartered one in March 1999
and its acquisition of Black Diamond are ways in which the Company solidified
its foundation for future growth.
Maintain a Friendly Environment for Employees and Customers. The
Company has instituted various programs to instill high morale among its
employees which the Company believes translates into exceptional customer
service. The Company also holds lively weekly sales meetings to elicit ideas
about products and services to emphasize. The Company believes that the overall
effect of these programs is to improve morale, customer service and financial
performance.
MARKET AREAS
For operational purposes, the Company groups its markets into four
regions, the Triad and Wilmington regions of North Carolina and the Norton and
Harrisonburg regions of Virginia. The Company's deposit market share in
Reidsville, North Carolina as of June, 1999, the most recent date for which data
are available, was 37.1%, which ranked first among banks and thrift
institutions, and in all of Rockingham County equaled 26.3% as of the same date,
which also ranked first. The Company's deposit market share in Norton, Virginia,
as of the same date, was 39.1%, which also ranked first among banks and thrift
institutions. The following table summarizes the banking offices, deposits and
market share for the Company's offices, categorized by city.
DEPOSITS AT DECEMBER 31,
------------------------------------
REGION/CITY 1999 1998 1997
- ----------- -------- -------- --------
(IN THOUSANDS)
TRIAD REGION:
Reidsville (1) ..... $177,480 $171,389 $152,221
Eden (2) ........... 59,406 54,040 45,305
Madison ............ 22,891 21,576 14,611
Ruffin ............. 9,244 7,418 5,014
Greensboro ......... 39,614 32,825 19,822
-------- -------- --------
Subtotal ..... 308,635 287,248 236,973
-------- -------- --------
WILMINGTON REGION:
Wilmington ......... 42,332 57,757 35,301
Burgaw ............. 6,995 -- --
-------- -------- --------
Subtotal ..... 49,327 57,757 35,301
-------- -------- --------
NORTON REGION:
Norton ............. 55,436 53,165 49,589
Pennington Gap ..... 25,913 22,720 22,708
Richlands .......... 23,018 21,408 19,581
-------- -------- --------
Subtotal ..... 104,367 97,293 91,878
-------- -------- --------
HARRISONBURG REGION:
Harrisonburg (3) ... 21,913 17,297 19,969
-------- -------- --------
Total ........ $484,242 $459,595 $384,121
======== ======== ========
- ------------------
(1) Includes three banking offices for all years.
(2) Includes two banking offices for 1999, and three offices for 1998 and 1997.
(3) Includes two banking offices for 1999, and one office for 1998 and 1997.
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The following is a summary description of the Company's market areas.
Triad - Rockingham County. Rockingham County was formed in 1785 and is
located in the north central area of North Carolina. It has a land area of 568
square miles and a population of approximately 90,000. Surrounding counties are
Guilford to the south, Caswell to the east and Stokes County to the west. The
county is bordered on the north by the Commonwealth of Virginia. Piedmont Triad
International Airport is located 20 miles away and Norfolk Southern has two rail
connection lines in the county. The area is served by U.S. Highways 29, 158 and
220. The county, which consists of several community oriented towns, provides a
full range of municipal services and extends financial support to certain
boards, agencies, and commissions to assist its efforts to serve its citizens.
Rockingham County's economy remained strong through 1999 with unemployment of
4.1% at September 1999.
Triad - Greensboro. Greensboro has a diverse economy attributable to a
blend of trade, manufacturing and service businesses. Local industry is
characterized by the production of a wide range of products, including textiles,
apparel, tobacco, machinery and electronics equipment. The area has access to
major domestic and international markets from Interstate Highways 40 and 85 and
U.S. Highways 29, 70, 220 and 421, major rail connections and the Piedmont Triad
International Airport. Entrepreneur magazine ranked the Triad area as fourth in
a list of the top 20 cities in which to establish a small business. According to
the North Carolina Employment Security Commission, the Triad area of North
Carolina reported an unemployment rate of 2.4% as of October, 1999.
Wilmington. Wilmington is the county seat and the industrial center of
New Hanover County and its recent rate of growth has been topped by only one
other city in North Carolina. The total population of New Hanover County is
approximately 150,000 and it is served by Interstate Highway 40 and U.S.
Highways 17 and 74, as well as major rail connections. The area is serviced by
national and regional airlines through facilities at the New Hanover
International Airport in New Hanover County. The New Hanover County area has
experienced extensive industrial development and service/trade sector growth
over the past 20 years. The Wilmington area industries produce fiber optic
cables for the communications industry, aircraft engine parts, pharmaceuticals,
nuclear fuel components and various textile products. The New Hanover County
area economy has become broadly diversified and has developed into a major
resort area, a busy sea port (one of North Carolina's only two deep water
ports), a light manufacturing center, a chemical manufacturing center and the
distribution hub of southeastern North Carolina. At October, 1999, the North
Carolina Employment Security Commission reported a 3.4% unemployment rate for
the Wilmington metropolitan area.
Norton Region. Norton is located in southwestern Virginia in the midst
of the Appalachian Mountains. The mining, retail and service industries of this
region operate from an abundant natural resource base that includes natural gas,
coal, timber and mineral deposits. The area is served by several U.S. highways
and by major rail connections. Black Diamond, headquartered in Norton, operates
branches in Norton (Wise County), Pennington Gap (Lee County) and Richlands
(Tazewell County). At May, 1999, the unemployment rate in Norton/Wise County
was 10.3%, an improvement over recent years.
Harrisonburg. Rockingham County is centrally located in the Shenandoah
Valley in west central Virginia. Harrisonburg, the county seat, is an important
educational, industrial, retail, tourism, commercial, agricultural and
governmental center. The area is served by Interstate Highway 81, several
primary U.S. highways, the Shenandoah Valley Regional Airport and major rail
connections. Black Diamond operates two branches in Harrisonburg, serving the
Counties of Rockingham and Augusta. According to the Virginia Employment
Commission, the November 1999 unemployment rate for Harrisonburg was 1.2%.
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LENDING ACTIVITIES
General. The Company offers a broad array of lending services,
including real estate, commercial and consumer loans, to individuals and small
to medium-sized businesses and other organizations that are located in or
conduct a substantial portion of their business in the Company's market areas.
The Company's total loans at December 31, 1999 were $414.0 million, or 74.0% of
total earning assets. The Company also makes secured construction loans to home
builders and residential mortgagees, which are often secured by first and second
real estate mortgages. At December 31, 1999, the Company had no large loan
concentrations (exceeding ten percent of its portfolio) in any particular
industry.
Loan Composition. The following table sets forth, at the dates
indicated, the composition of the Company's loan portfolio and the related
percentage composition.
Year Ended December 31
-------------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -------------------
Real Estate:
Commercial $115,434 27.9% $ 94,798 26.2% $ 60,659 19.0%
Residential 130,676 31.6% 120,143 33.2% 120,257 37.7%
Construction 34,680 8.4% 29,794 8.2% 22,143 6.9%
-------- ----- -------- ----- -------- -----
Total real estate 280,790 67.9% 244,735 67.6% 203,059 63.6%
Commercial, financial and
agricultural 58,002 14.0% 49,822 13.8% 57,453 18.0%
-------- ----- -------- ----- -------- -----
Consumer:
Direct 32,778 7.9% 32,368 8.9% 31,556 9.9%
Home equity 32,836 7.9% 26,723 7.4% 21,425 6.7%
Revolving 9,605 2.3% 8,604 2.3% 5,974 1.8%
-------- ----- -------- ----- -------- -----
Total consumer 75,219 18.1% 67,695 18.6% 58,955 18.4%
-------- ----- -------- ----- -------- -----
Total $414,011 100.0% $362,252 100.0% $319,467 100.0%
======== ===== ======== ===== ======== =====
Real Estate Loans. Loans secured by real estate for a variety of
purposes constituted $280.8 million, or 67.9%, of the Company's total loans at
December 31, 1999. The Company held at December 31, 1999 real estate loans of
various sizes ranging up to $4.9 million, secured by office buildings, retail
establishments, warehouses, motels, restaurants and other types of property.
Loan terms are typically limited to five years, although the installment
payments may be structured generally on a 15-year amortization basis. Interest
rates may be fixed or adjustable, based on market conditions, and the Company
generally charges an origination fee. Management has attempted to reduce credit
risk in the real estate portfolio by emphasizing loans on owner occupied office
and retail buildings where the loan to value ratio, established by independent
appraisals, does not exceed 80% and net project cash flow available for debt
service equals 120% of the debt service requirement. The Company also often
requires personal guarantees of the principal owners of the property and obtains
personal financial statements of the principal owners in such cases. The Company
experienced no net loan losses on commercial real estate loans during 1999, 1998
and 1997.
The Company originates residential loans for its portfolio on single
and multi-family properties, both owner occupied and non-owner occupied, and at
December 31, 1999 it held $130.7 million of such loans. Loan terms are typically
limited to five years, with payments through the date of maturity generally
based on a 15 or 30 year amortization schedule. Rates may be fixed or variable,
and the
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Company typically charges an origination fee. The Company attempts to minimize
credit risk by requiring a loan to value ratio of 80% or less. The Company
experienced no loan losses in 1999, net loan losses of $4,000 in 1998, and net
loan recoveries of $180,000 in 1997.
The Company also originates residential loans for sale into the
secondary market. Through its mortgage banking division, the Company originates
both fixed and variable rate residential mortgage loans for sale with servicing
released. The Company is able to generate loan origination fees, typically
ranging from 1.0% to 1.5% of the loan balance which are recognized in income
when the loan is sold. During 1999, 1998 and 1997, the Company earned loan
origination fees of $249,000, $258,000 and $239,000, respectively. At December
31, 1999, the Company held $754,000 of such loans for sale, and during 1999 the
Company sold an aggregate of $3.8 million of such loans. The Company sells these
loans on a non-recourse basis.
The Company's current strategy is for the majority of construction and
development loans on commercial and residential projects to be in the range of
$0.3 million to $2.5 million, not to exceed $2.5 million. At December 31, 1999,
1998 and 1997, the Company held $34.7 million, $29.8 million and $22.1 million,
respectively, of such loans. To reduce credit risk associated with such loans,
the Company limits its lending to projects involving small commercial centers
that have strong anchor tenants and are otherwise substantially pre-leased, or
residential projects that are either presold or are being built by the proposed
occupant. The leases on commercial projects must generally result in a loan to
capitalized lease value of no greater than 75% and a net cash flow to debt
service ratio of at least 120%. The Company historically has required a personal
guarantee from the developer or builder. Loan terms are typically 12 to 15
months on a commercial project and nine months on a residential project,
although the Company occasionally will make a "mini-permanent" loan for purposes
of construction and development up to a three to five year term. Rates are
typically variable and the Company typically charges an origination fee. During
1999, the Company experienced no net loan losses, losses of $48,000 in 1998,
and no such losses in 1997.
Commercial Loans. The Company makes loans for commercial purposes in
various lines of businesses. At December 31, 1999, the Company held $58.0
million of commercial loans, or 14.0% of its total loan portfolio. Equipment
loans are typically made on terms up to five years at fixed or variable rates,
with the financed equipment pledged as collateral to the Company. The Company
attempts to reduce its credit risk on these loans by limiting the loan to value
ratio to 80%. Working capital loans are made on terms typically not exceeding
one year. These loans may be secured or unsecured, but the Company attempts to
limit its credit risk by requiring the borrower to demonstrate the capacity to
produce net cash flow available for debt service of 125% to 150% of debt service
requirements. During 1999, the Company experienced a $5,000 net recovery on
commercial loans, net loan losses of $537,000 in 1998, and net loan losses of
$6,000 in 1997.
Consumer Loans. The Company makes a variety of loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans originated directly by the Company, home equity revolving lines of
credit, and unsecured revolving lines of credit. The home equity loans and
certain of the direct loans are secured by the borrower's residence, but the
Company attempts to underwrite the credit independent of the collateral value.
At December 31, 1999, the Company held $75.2 million of consumer loans,
including home equity revolving lines of credit. During 1999, 1998 and 1997,
respectively, the Company experienced net consumer loan losses of $249,000,
$204,000 and $77,000.
Credit Card Loans. In 1996, the Company began offering credit card
loans to individuals and businesses who meet the Company's underwriting
standards with respect to income, credit rating,
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established residence and employment. Credit card loans are subject to seasonal
fluctuations based on consumer spending habits, with the outstanding balances of
such loans rising at the end of each calendar year. At December 31, 1999, credit
card loans equaled approximately $4.4 million, or approximately 1.1% of the
Company's total loan portfolio. Net losses on credit card loans equaled $173,000
in 1999, $110,000 in 1998 and $19,000 in 1997. In February, 2000, the Company
sold its entire credit card portfolio of $3.4 million to a third party. The
Company received approximately a 3% premium on this sale. The loans were sold
without recourse.
Loan Approval and Review. The Company's loan approval policies provide
for various levels of officer lending authority. When the aggregate outstanding
loans to a single borrower exceeds that individual officer's lending authority,
the loan request must be considered and approved by an officer with a higher
lending limit. Branch loan officers typically have lending limits up to
$250,000; loans in excess of that limit must be approved by the city executive.
If the lending request exceeds the city executive's lending limit, which is
$500,000, the loan must be submitted to and approved by the appropriate senior
credit officer. The senior credit officer has authority to approve a loan up to
$750,000. Under joint approval, the senior credit officer and the senior vice
president -- corporate administration, may approve loans up to $1.5 million. All
loans in excess of $1.5 million must be approved by the President and Chief
Executive Officer, who may approve loans of up to $2.5 million.
The Company has a continuous loan review procedure involving multiple
officers of the Company which is designed to promote early identification of
credit quality problems through its credit management committee. All loan
officers are charged with the responsibility of reviewing no less than annually
all credit relationships in excess of $100,000 in their respective portfolios.
All new relationships, that is, those not more than 60 days old, in excess of
$100,000 are reviewed by a credit management committee comprised of loan
officers and senior management every two weeks. Loan officers also review all
criticized and classified assets in their portfolio quarterly with the senior
loan officers of the Company. The officers are responsible for implementing,
where appropriate, approved action plans with respect to such criticized and
classified assets designed to improve the Company's credit position for an early
resolution of the problem loan. As part of its overall strategy to improve
policies and procedures, the Company also engaged a third party consultant to
review its loan portfolio, the first examination of which occurred in 1998. The
Company has used the findings of the examination to further enhance credit
quality through improved credit administration policies and procedures.
The Company's credit review system supplements the Company's loan
rating system, pursuant to which the Company may place the loan on its
criticized asset list or may classify the loan in one of various other
classification categories. A specified minimum percentage of loans in each
adverse asset classification category, based on the historical loss experience
in the Company in each such category, is used to determine the adequacy of the
Company's allowance for loan and lease losses quarterly. These credits are also
individually reviewed by senior credit officers of the Company to determine
whether a greater allowance allocation is justified due to the facts and
circumstances of a particular adversely classified loan.
Outsourcing of Certain Operational Functions. The Company has
agreements with third parties to provide a variety of specialized functions to
the Company in connection with its lending operations. In each of these
relationships, the Company benefits from the service provider's expertise and
economies of scale while retaining the flexibility to take advantage of changes
in available technology without impacting customer service.
DEPOSITS
The Company offers a variety of deposit programs to individuals and to
small and medium-sized businesses and other organizations at interest rates
generally competitive with local market conditions.
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The following table sets forth the mix of depository accounts at the Company as
a percentage of total deposits at the dates indicated.
AT DECEMBER 31,
---------------------------------
1999 1998 1997
----- ----- -----
Non-interest bearing demand 9.9% 9.8% 9.5%
Savings/NOW/MMI ........... 19.2% 19.0% 16.9%
Certificates of deposit ... 70.9% 71.2% 73.6%
----- ----- -----
100.0% 100.0% 100.0%
===== ===== =====
The Company accepts deposits at its 15 banking offices, eight of which
have automated teller machines. In addition, the Company operates a network of
34 ATMs in Norton, Virginia and the surrounding area. The Company's memberships
in the "HONOR", "CIRRUS" and "PLUS" networks allow customers access to their
depository accounts from regional ATM facilities. The Company charges fees
ranging from $1.50 to $1.75 per transaction for the use of its ATM facilities by
those who are not depositors with the Company. See "Properties." The Company
controls deposit flows primarily through the pricing of such deposits and to a
certain extent through promotional activities, such as its "Prestige" and
"Priority" accounts for deposits of $25,000 and $75,000, respectively, and the
"FNB Club" which extends special privileges and sponsors group excursions to
sites and performances of interest to account holders over the age of 55. The
Company also offers as a convenience to come to a customer's home or place of
business to pick up a non-cash deposit the customer wishes to make. At December
31, 1999, the Company had $133.4 million in certificates of deposit of $100,000
or more. In January 1998, the Company joined an electronic network which allows
it to post interest rates and attract certificates of deposit nationally. The
investors are generally credit unions or commercial banks and amounts are
typically just under $100,000, to assure FDIC insurance coverage. Deposit rates
are set weekly by senior management of the Company. Management believes that the
rates it offers are competitive with those offered by other institutions in the
Company's market areas.
INVESTMENT SERVICES
The Company offers the services of an investment advisor employed by
American Express Financial Advisors who splits his time among six of the
Company's branches and is available to depositors, as well as those who are not
account holders in the Company. This advisor offers mutual fund services, tax
and estate planning and other financial services and the Company receives a
commission based on the advisor's sales. The Company benefits by attracting
customers to its branches who may not otherwise have reason to transact business
there and by earning additional fees. In 1999, the Company earned fees in the
amount of $52,000 from commissions generated from these services.
MARKETING
The Company currently markets its services through advertising
campaigns and in printed material, such as newspapers, magazines and direct
mailings, as well as through promotional items, such as caps, pens, pencils and
shirts. The Company's officers are also heavily involved in local civic affairs
and philanthropic organizations in order to focus customers on products and
services at a personal level. The Company occasionally sponsors community events
and holds grand opening ceremonies for its new branches to which local
dignitaries are invited to speak and participate in the festivities. Since the
Company does not have a fully-staffed marketing department, the Company's
marketing, advertising and public relations campaigns focus on the following two
components:
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o Value. Among other things, the Company offers attractive rates
for its financial products, including its certificates of
deposit and checking accounts. This pricing structure has been
successful in attracting depositors who are motivated by the
Company's rates, as well as by the variety of individualized
services the Company promotes and offers.
o Convenience and Service. All personnel of the Company aim
toward serving the individual needs of the Company's
customers. For example, senior personnel are accessible on
very short notice, even after normal banking hours, by way of
pagers and other means. In addition, all employees are
eligible to earn incentive compensation for sales and
cross-sales to customers.
Management intends to continue to market the Company's services through
a combination of advertising campaigns, public relations activities and local
affiliations. In most of its markets, the Company has established advisory
boards, comprised of local community leaders, to promote the Company. While the
key messages of value, convenience, service and reliability will continue to
play a major role in the Company's marketing and public relations efforts,
management may also focus on targeted groups, such as professionals, in addition
to small to medium-sized local businesses.
A vital part of the Company's marketing plan is the execution of a
public relations strategy. Many traditional public relations methods will be
used in promoting its services. Management intends to pursue media coverage,
including general press, industry periodicals and other media covering banking
and finance, consumer issues and special interests. Press releases, quarterly
shareholder reports, media alerts and presentations will announce new banking
services as they are added. In addition, a professional marketing firm has been
engaged by the Company to assist in promoting the overall image of the Company
to the general public and investment community.
COMPETITION
Commercial banking in the Southeast is extremely competitive, due in
large part to interstate branching. Currently, many of the Company's competitors
are significantly larger and have greater resources than the Company. The
Company continues to encounter significant competition from a number of sources,
including bank holding companies, commercial banks, thrift institutions, credit
unions, and other financial institutions and financial intermediaries. The
Company competes in its market areas with some of the largest banking
organizations in the Southeast, several of which have as many as 200 to 300
branches in North Carolina and Virginia. The Company's competition is not
limited to financial institutions based in North Carolina and Virginia. The
enactment of federal legislation authorizing nationwide interstate banking has
greatly increased the size and financial resources of some of the Company's
competitors. Consequently, many of the Company's competitors have substantially
higher lending limits due to their greater total capitalization, and many
perform functions for their customers, such as trust services that the Company
does not offer. As a result of the interstate banking legislation, the Company's
market is open to future penetration by banks located in other states provided
the other state allows acquisitions of its banking institutions by North
Carolina banking institutions, thereby increasing competition.
The management of the Company believes banks compete in the following
areas: convenience of location, interest rates for deposits and loans, types of
accounts and services offered, and quality of the personnel providing services.
In its early years, the Company sought to attract depositors and borrowers
primarily through offering competitive interest rates for both loans and
deposits. More recently, the Company has determined to compete primarily through
the quality of its services, experience of its
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personnel and community oriented approach. The Company also relies on the
personal contacts of its officers and directors to attract depositors and
borrowers in its target market of small to medium-sized businesses. In addition
to its central Board of Directors, the Company has established local advisory
boards in most of the communities served to promote contacts in the business
communities.
EMPLOYEES
As of December 31, 1999, the Company had approximately 182 full-time
and 13 part-time employees. None of the employees of the Company are represented
by any collective bargaining unit. The Company considers its relations with its
employees to be good.
SUPERVISION AND REGULATION
The following discussion is intended to be a summary of the material
regulations and policies applicable to the Company and its wholly-owned
subsidiaries, FNB Southeast and Black Diamond, and does not purport to be a
comprehensive discussion. The Company and its subsidiaries are extensively
regulated under both federal and state law. Generally, these laws and
regulations are intended to protect depositors and borrowers, not shareholders.
To the extent that the following information describes statutory and regulatory
provisions, it is qualified in its entirety by reference to the particular
statutory and regulatory provisions. Any change in applicable law or regulation
may have a material effect on the business of the Company and its subsidiaries.
REGULATION OF THE COMPANY
GENERAL. The Company is a bank holding company, registered with the
Board of Governors of the Federal Reserve ("Federal Reserve") under the Bank
Holding Company Act of 1956 ("BHC Act") and with the North Carolina Commissioner
of Banks (the "Commissioner") under the North Carolina Bank Holding Company Act
of 1984, as amended (the "North Carolina Act"). As such, the Company and its
subsidiaries are subject to the supervision, examination, and reporting
requirements of the BHC Act and the North Carolina Act and the regulations of
the Federal Reserve and the Commissioner.
Prior to March 15, 1999, FNB Southeast was a national bank regulated by
the Office of the Comptroller of the Currency ("OCC"). Effective March 15, 1999,
FNB Southeast converted its charter from a national bank to a North Carolina
state bank and became a member of the Federal Reserve.
The Company is a member of the Federal Deposit Insurance Corporation
("FDIC"), and as such, its deposits are insured by the FDIC to the extent
provided by law. The Company is also subject to numerous state and federal
statutes and regulations that affect its business, activities, and operations.
As a North Carolina bank and member of the Federal Reserve, the Company is
supervised and examined by the Federal Reserve and the Commissioner, and is also
subject to the backup supervisory authority of the FDIC. Such agencies regularly
examine the operations of the Company and are given authority to approve or
disapprove mergers, consolidations, the establishment of branches, and similar
corporate actions. Such agencies also have the power to prevent the continuance
or development of unsafe or unsound banking practices or other violations of
law.
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BANK HOLDING COMPANY REGULATION. The Company, as a bank holding
company, is also subject to examination, regulation and periodic reporting under
the Bank Holding Company Act of 1956, as amended ("BHC Act"), as administered by
the Federal Reserve. The Federal Reserve has adopted capital adequacy guidelines
for bank holding companies on a consolidated basis.
The Company is required to obtain the prior approval of the Federal
Reserve to acquire all, or substantially all, of the assets of any bank or bank
holding company. Prior Federal Reserve approval is also required for the Company
to acquire direct or indirect ownership or control of any voting securities of
any bank or bank holding company if, after giving effect to such acquisition, it
would, directly or indirectly, own or control more than 5% of any class of
voting shares of such bank or bank holding company.
The Company is required to give the Federal Reserve prior written
notice of any purchase or redemption of its outstanding equity securities if the
gross consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the Company's consolidated net worth. The
Federal Reserve may disapprove such a purchase or redemption if it determines
that the proposal would constitute an unsafe and unsound practice, or would
violate any law, regulation, Federal Reserve order or directive, or any
condition imposed by, or written agreement with, the Federal Reserve. Such
notice and approval is not required for a bank holding company that would be
treated as "well capitalized" under applicable regulations of the Federal
Reserve, that has received a composite "1" or "2" rating at its most recent bank
holding company inspection by the Federal Reserve, and that is not the subject
of any unresolved supervisory issues.
The status of the Company as a registered bank holding company under
the BHC Act does not exempt it from certain federal and state laws and
regulations applicable to corporations generally, including, without limitation,
certain provisions of the federal securities laws.
In addition, a bank holding company is prohibited generally from
engaging in, or acquiring 5% or more of any class of voting securities of any
company engaged in, non-banking activities. One of the principal exceptions to
this prohibition is for activities found by the Federal Reserve Board to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. Some of the principal activities that the Federal Reserve has
determined by regulation to be so closely related to banking as to be a proper
incident thereto are:
o making or servicing loans;
o performing certain data processing services;
o providing discount brokerage services;
o acting as fiduciary, investment or financial advisor;
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o leasing personal or real property;
o making investments in corporations or projects designed
primarily to promote community welfare; and
o acquiring a savings and loan association.
Under the Financial Institutions Reform, Recovery, and Enforcement Act
of 1989, depository institutions are liable to the FDIC for losses suffered or
anticipated by the FDIC in connection with the default of a commonly controlled
depository institution or any assistance provided by the FDIC to such an
institution in danger of default.
Subsidiary banks of a bank holding company, such as FNB Southeast and
Black Diamond, are subject to certain quantitative and qualitative restrictions
imposed by the Federal Reserve Act on any extension of credit to, or purchase of
assets from, or letter of credit on behalf of, the bank holding company or its
subsidiaries, and on the investment in or acceptance of stocks or securities of
such holding company or its subsidiaries as collateral for loans. In addition,
provisions of the Federal Reserve Act and Federal Reserve regulations limit the
amounts of, and establish required procedures and credit standards with respect
to, loans and other extensions of credit to officers, directors and principal
stockholders of the Company, FNB Southeast, Black Diamond, and related interests
of such persons. Moreover, subsidiaries of bank holding companies are prohibited
from engaging in certain tie-in arrangements (with the holding company or any of
its subsidiaries) in connection with any extension of credit, lease or sale of
property or furnishing of services.
CAPITAL REQUIREMENTS. The federal banking regulators have adopted
certain risk-based capital guidelines to assist in the assessment of the capital
adequacy of a banking organization's operations for both transactions reported
on the balance sheet as assets and transactions, such as letters of credit, and
recourse arrangements, which are recorded as off balance sheet items. These
guidelines apply to the Company and its bank subsidiaries. Under these
guidelines, nominal dollar amounts of assets and credit equivalent amounts of
off balance sheet items are multiplied by one of several risk adjustment
percentages which range from 0% for assets with low credit risk, such as certain
U.S. Treasury securities, to 100% for assets with relatively high credit risk,
such as business loans.
A banking organization's risk-based capital ratios are obtained by
dividing its qualifying capital by its total risk adjusted assets. The
regulators measure risk-adjusted assets, which include off balance sheet items,
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. "Tier 1," or core capital,
includes common equity, qualifying noncumulative perpetual preferred stock and
minority interests in equity accounts of consolidated subsidiaries, less
goodwill and other intangibles, subject to certain exceptions. "Tier 2," or
supplementary capital, includes among other things, limited-life and perpetual
preferred stock, hybrid capital instruments, mandatory convertible securities,
qualifying subordinated debt, and the allowance for loan and lease losses,
subject to certain limitations and less required deductions. The inclusion of
elements of Tier 2 capital is subject to certain other requirements and
limitations of the federal banking agencies. Banks and bank holding companies
subject to the risk-based capital guidelines are required to maintain a ratio of
Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total
capital to risk-weighted assets of at least 8%. The appropriate regulatory
authority may set higher capital requirements when particular circumstances
warrant.
RECENT DEVELOPMENTS. On November 12, 1999, the President of the United
States signed into law the Gramm-Leach-Bliley Act ("GLB"), which alters the
regulatory framework for banking and other
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financial services companies. The GLB creates a new type of holding company
called a "financial holding company." The new financial holding company
structure allows banks, insurance companies, and securities firms to affiliate
within a single entity, provided that the financial holding company satisfies
and maintains certain new regulatory standards. Bank holding companies that meet
these standards may elect to become financial holding companies, but if they
remain bank holding companies, they are subject to the restrictions on their
activities existing prior to the GLB, including those restrictions described
above imposed by the BHC Act.
The Company has not elected to become a financial holding company, so
it remains under essentially the same regulatory framework as it did before the
enactment of the GLB. However, the financial holding company structure created
by the GLB would allow insurance companies or securities firms operating under
the financial holding company structure to acquire the Company, and, if the
Company elects to become a financial holding company in the future, it could
acquire insurance companies or securities firms.
In addition to creating the more flexible financial holding company
structure, GLB introduced several additional customer privacy protections that
will apply to the Company and its subsidiaries. Federal regulators have issued a
draft of proposed privacy regulations implementing these protections for
comment. Pursuant to the GLB's rulemaking provisions, regulations must be
adopted by May 12, 2000, and institutions must begin privacy disclosures under
the GLB within six months of adoption of such regulations. The GLB's privacy
provisions require financial institutions to, among other things, (i) establish
and annually disclose a privacy policy, (ii) give consumers the right to opt out
of disclosures to nonaffiliated third parties, with certain exceptions, (iii)
refuse to disclose consumer account information to third-party marketers and
(iv) follow regulatory standards to protect the security and confidentiality of
consumer information.
REGULATION OF FNB SOUTHEAST
STATE LAW. The Company's wholly-owned subsidiary bank, FNB Southeast,
is also subject to extensive supervision and regulation by the Commissioner. The
Commissioner oversees state laws that set specific requirements for bank capital
and regulate deposits in, and loans and investments by, banks, including the
amounts, types, and in some cases, rates. The Commissioner supervises and
performs periodic examinations of North Carolina-chartered banks to assure
compliance with state banking statutes and regulations, and FNB Southeast is
required to make regular reports to the Commissioner describing in detail the
resources, assets, liabilities and financial condition of FNB Southeast. Among
other things, the Commissioner regulates mergers and consolidations of
state-chartered banks, the payment of dividends, loans to officers and
directors, record keeping, types and amounts of loans and investments, and the
establishment of branches.
DEPOSIT INSURANCE. As a member institution of the FDIC, FNB Southeast's
deposits are insured up to a maximum of $100,000 per depositor through the Bank
Insurance Fund ("BIF"), administered by the FDIC, and each member institution is
required to pay semi-annual deposit insurance premium assessments to the FDIC.
The BIF assessment rates have a range of 0 cents to 27 cents for every $100 in
assessable deposits. Also, banks are required to pay additional annual
assessments at rates set by the Financing Corporation, which was established by
the Competitive Equality Banking Act of 1987.
Failure to meet applicable capital guidelines could subject a banking
organization to a variety of enforcement actions, including limitations on its
ability to pay dividends, the issuance by the applicable regulatory authority of
a capital directive to increase capital and, in the case of depository
institutions,
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the termination of deposit insurance by the FDIC, as well as the measures
described under the "Federal Deposit Insurance Corporation Improvement Act of
1991" below, as applicable to undercapitalized institutions. In addition, future
changes in regulations or practices could further reduce the amount of capital
recognized for purposes of capital adequacy. Such a change could affect the
ability of FNB Southeast to grow and could restrict the amount of profits, if
any, available for the payment of dividends to the shareholders.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. In
December, 1991, Congress enacted the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), which substantially revised the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and made
significant revisions to several other federal banking statutes. FDICIA provides
for, among other things:
o publicly available annual financial condition and management
reports for certain financial institutions, including audits
by independent accountants,
o the establishment of uniform accounting standards by federal
banking agencies,
o the establishment of a "prompt corrective action" system of
regulatory supervision and intervention, based on
capitalization levels, with greater scrutiny and restrictions
placed on depository institutions with lower levels of
capital,
o additional grounds for the appointment of a conservator or
receiver, and
o restrictions or prohibitions on accepting brokered deposits,
except for institutions which significantly exceed minimum
capital requirements.
A central feature of FDICIA is the requirement that the federal banking
agencies take "prompt corrective action" with respect to depository institutions
that do not meet minimum capital requirements. Pursuant to FDICIA, the federal
bank regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions that
they supervise. Under these regulations, a depository institution is classified
in one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." An institution may be deemed by the regulators to
be in a capitalization category that is lower than is indicated by its actual
capital position if, among other things, it receives an unsatisfactory
examination rating with respect to asset quality, management, earnings or
liquidity.
FDICIA provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution. FDICIA also limits the circumstances under which the FDIC
is permitted to provide financial assistance to an insured institution before
appointment of a conservator or receiver.
COMMUNITY REINVESTMENT ACT. FNB Southeast is also subject to the
Community Reinvestment Act ("CRA"), which requires the appropriate federal bank
regulatory agency, in connection with its examination of a bank, to assess a
bank's record in meeting the credit needs of the community served by that bank,
including low and moderate-income neighborhoods. Each institution is assigned
one of the following four ratings of its record in meeting community credit
needs: "outstanding," "satisfactory," "needs to improve" or "substantial
noncompliance." The regulatory agency's assessment of the bank's
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record is made available to the public. Further, such assessment is required of
any bank which has applied to (i) charter a national bank, (ii) obtain deposit
insurance coverage for a newly chartered institution, (iii) establish a new
branch office that will accept deposits, (iv) relocate an office or (v) merge or
consolidate with, or acquire the assets or assume the liabilities of, a
federally regulated financial institution. In the case of a bank holding company
applying for approval to acquire a bank or other bank holding company, the
Federal Reserve will assess the record of each subsidiary bank of the applicant
bank holding company, and such records may be the basis for denying the
application.
Effective May 12, 2000, the GLB's "CRA Sunshine Requirements" call for
financial institutions to disclose publicly certain written agreements made in
fulfillment of the CRA. Banks that are parties to such agreements also must
report to federal regulators the amount and use of any funds expended under such
agreements on an annual basis, along with such other information as regulators
may require. This annual reporting requirement is effective for any agreements
made after May 12, 2000.
MISCELLANEOUS. The dividends that may be paid by FNB Southeast are
subject to legal limitations. In accordance with North Carolina banking law,
dividends may not be paid unless FNB Southeast's capital surplus is at least 50%
of its paid-in capital.
Shareholders of banks may be compelled by bank regulatory authorities
to invest additional capital in the event their bank's capital shall have become
impaired by losses or otherwise. Failure to pay such an assessment could result
in a forced sale of a shareholder's bank stock.
The earnings of FNB Southeast will be affected significantly by the
policies of the Federal Reserve, which is responsible for regulating the United
States money supply in order to mitigate recessionary and inflationary
pressures. Among the techniques used to implement these objectives are open
market transactions in United States government securities, changes in the rate
paid by banks on bank borrowings, and changes in reserve requirements against
bank deposits. These techniques are used in varying combinations to influence
overall growth and distribution of bank loans, investments, and deposits, and
their use may also affect interest rates charged on loans or paid for deposits.
The monetary policies of the Federal Reserve have had a significant
effect on the operating results of commercial banks in the past and are expected
to continue to do so in the future. In view of changing conditions in the
national economy and money markets, as well as the effect of actions by monetary
and fiscal authorities, no prediction can be made as to possible future changes
in interest rates, deposit levels, loan demand or the business and earnings of
FNB Southeast.
REGULATION OF BLACK DIAMOND
GENERAL. Black Diamond is a federally chartered savings bank, the
deposits of which are federally insured and backed by the full faith and credit
of the United States Government. Accordingly, Black Diamond is subject to broad
federal regulation and oversight extending to all its operations. Black Diamond
is a member of the Federal Home Loan Bank ("FHLB") of Atlanta and is subject to
certain limited regulation by the Federal Reserve Board. Black Diamond is a
member of the Savings Association Insurance Fund ("SAIF") of the FDIC, which
insures its deposits. As a result, the FDIC has certain regulatory and
examination authority over Black Diamond.
On March 15, 2000 the Company filed an application with the Office of
the Commission of Banks for the State of North Carolina to merge Black Diamond
into FNB Southeast. The effect of the merger, if approved, would be to operate
Black Diamond locations as branches of FNB Southeast.
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FEDERAL REGULATION OF SAVINGS ASSOCIATIONS. The Office of Thrift
Supervision ("OTS") has extensive authority over the operations of savings
associations. As part of this authority, Black Diamond is required to file
periodic reports with the OTS and is subject to periodic examinations by the OTS
and the FDIC. When these examinations are conducted by the OTS and the FDIC, the
examiners may require Black Diamond to provide for higher general or specific
loan loss reserves.
The OTS also has extensive enforcement authority over all savings
institutions, including Black Diamond. This enforcement authority includes,
among other things, the ability to assess civil money penalties, to issue
cease-and-desist or removal orders and to initiate injunctive actions. In
general, these enforcement actions may be initiated for violations of laws and
regulations and unsafe or unsound practices. Other actions or inactions may
provide the basis for enforcement action, including misleading or untimely
reports filed with the OTS. Except under certain circumstances, public
disclosure of final enforcement actions by the OTS is required.
In addition, the investment, lending and branching authority of Black
Diamond is prescribed by federal laws, and regulations, and it is prohibited
from engaging in any activities not permitted by such laws and regulations. For
instance, no savings institution may invest in non-investment grade corporate
debt securities. In addition, the permissible level of investment by federal
associations in loans secured by non-residential real property may not exceed
400% of total capital, except with approval of the OTS. Federal savings
associations are also generally authorized to branch nationwide. Black Diamond
is in compliance with the noted restrictions.
Black Diamond's general permissible lending limit for
loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired
capital and surplus (except for loans fully secured by certain readily
marketable collateral, in which case this limit is increased to 25% of
unimpaired capital and surplus). At December 31, 1999, Black Diamond's lending
limit under this restriction was $1.26 million. Black Diamond is in compliance
with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, internal controls and audit systems, interest
rate risk exposure and compensation and other employee benefits. Any institution
which fails to comply with these standards must submit a capital compliance
plan. A failure to submit a plan or to comply with an approved plan will subject
the institution to further enforcement action. The OTS and the other federal
banking agencies have also adopted additional guidelines on asset quality and
earnings standards. The guidelines are designed to enhance early identification
and resolution of problem assets.
The guidelines are not expected to materially affect Black Diamond.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC. The FDIC is an
independent federal agency that insures deposits of banks and thrift
institutions up to certain specified limits and regulates such institutions for
safety and soundness. The FDIC administers two separate insurance funds, the BIF
for commercial banks and state savings banks, and the SAIF for savings
associations such as Black Diamond and banks that have acquired deposits from
savings associations. The FDIC is required to maintain designated levels of
reserves in each fund.
The FDIC is authorized to establish separate annual assessment rates
for deposit insurance for members of the BIF and members of the SAIF. The FDIC
may increase assessment rates for either fund if necessary to restore the fund's
ratio of reserves to insured deposits to the target level within a reasonable
time, and may decrease these rates if the target level has been met. The FDIC
has established
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a risk-based assessment system for both SAIF and BIF members. Under this system,
assessments vary depending on the risk the institution poses to its deposit
insurance fund. An institution's risk level is determined based on its capital
levels, and the FDIC's level of supervisory concern about the institution.
REGULATORY CAPITAL REQUIREMENTS. Federally insured savings
associations, such as Black Diamond, are required to maintain a minimum level of
regulatory capital. The OTS has established capital standards, including a
tangible capital requirement, a leverage ratio (or core capital) requirement and
a risk-based capital requirement applicable to such savings associations. These
capital requirements must be generally as stringent as the comparable capital
requirements for national banks. The OTS is also authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
On December 31, 1999, Black Diamond had total risk based capital of
$10.5 million (including approximately $9.2 million in core capital and $1.3
million in qualifying supplementary capital) and risk-weighted assets of $88.0
million (with no converted off-balance sheet assets); or total capital of 11.9%
of risk-weighted assets. This amount was $3.5 million above the 8% requirement
in effect on that date.
THRIFT CHARTER. Congress has considered legislation in various forms
that would require federal thrifts, such as Black Diamond, to convert their
charters to national or state bank charters. Black Diamond cannot determine
whether, or in what form, such legislation may eventually be enacted and there
can be no assurance that any legislation that is enacted would not adversely
affect Black Diamond and the Company.
PROMPT CORRECTIVE REGULATORY ACTION. Under the OTS Prompt Corrective
Action regulations, the OTS is required to take certain supervisory actions
against undercapitalized institutions, the severity of which depends upon the
institution's degree of capitalization. Generally, a savings institution that
has total risk-based capital of less than 8.0% or a leverage ratio or a Tier 1
core capital ratio that is less than 4.0% is considered to be undercapitalized.
A savings institution that has total risk-based capital of less than 6.0%, a
Tier 1 core risk-based capital ratio of less than 3.0% or a leverage ratio that
is less than 3.0% is considered to be "significantly undercapitalized," and a
savings institution that has a tangible capital to assets ratio equal to or less
than 2.0% is deemed to be "critically undercapitalized." Subject to a narrow
exception, the banking regulator is required to appoint a receiver or
conservator for an institution that is "critically undercapitalized." The
regulation also provides that a capital restoration plan must be filed with the
OTS within 45 days of the date an institution receives notice that it is
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." In addition, numerous mandatory supervisory actions become
immediately applicable to the institution, including, but not limited to,
restrictions on growth, investment activities, capital distributions, and
affiliate transactions. The OTS may also take any one of a number of
discretionary supervisory actions, including the issuance of a capital directive
and the replacement of senior executive officers and directors.
At December 31, 1999, Black Diamond was categorized as "well
capitalized," meaning that Black Diamond's total risk-based capital ratio
exceeded 10.0%, Tier I risk-based capital ratio exceeded 6.0%, leverage capital
ratio exceeded 5.0%, and Black Diamond was not subject to a regulatory order,
agreement or directive to meet and maintain a specific capital level for any
capital measure.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. OTS
regulations applicable to Black Diamond govern capital distributions by savings
institutions, which include cash dividends, stock redemptions or repurchases,
cash-out mergers, interest payments on certain convertible debt and other
transactions charged to the capital account of a savings institution to make
capital distributions.
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Generally, the regulations create a safe harbor for specified levels of capital
distributions for institutions meeting at least their minimum capital
requirements, so long as such institutions notify the OTS and receive no
objection to the distribution from the OTS. Institutions and distributions that
do not qualify for the safe harbor are required to obtain prior OTS approval
before making any capital distributions.
Pursuant to a recent revision to these regulations, effective April 1,
1999, a "well capitalized" savings association, such as Black Diamond, will be
permitted to make capital distributions during a calendar year in an amount up
to the savings association's net income for the year plus the savings
association's retained net income for the preceding two years, without filing an
application for approval of the capital distribution with the OTS.
LIQUIDITY. All savings associations, including Black Diamond, are
required to maintain an average daily balance of liquid assets equal to a
certain percentage of the sum of its average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less. This liquid asset
ratio requirement may vary from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings associations.
ACCOUNTING. An OTS policy statement applicable to all savings
associations clarifies and re-emphasizes that the investment activities of a
savings association must be in compliance with approved and documented
investment policies and strategies, and must be accounted for in accordance with
GAAP. Under the policy statement, management must support its classification of
and accounting for loans and securities (i.e., whether held for investment, sale
or trading) with appropriate documentation.
The OTS has adopted an amendment to its accounting regulations, which
may be more stringent than GAAP, to require that transactions be reported in a
manner that best reflects their underlying economic substance and inherent risk
and that financial reports must incorporate any other accounting regulations or
orders prescribed by the OTS. Black Diamond is in compliance with these amended
rules.
QUALIFIED THRIFT LENDER TEST. All savings associations, including Black
Diamond, are required to meet a qualified thrift lender ("QTL") test to avoid
certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. Such assets primarily consist of residential
housing related loans and investments. At December 31, 1999, Black Diamond met
the test and has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties.
COMMUNITY REINVESTMENT ACT. The CRA requires the OTS, in connection
with the examination of Black Diamond, to assess the institution's record of
meeting the credit needs of its community and to
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take such record into account in its evaluation of certain applications, such as
a merger or the establishment of a branch, by Black Diamond. An unsatisfactory
rating may be used as the basis for the denial of an application by the OTS.
The federal banking agencies, including the OTS, have recently revised
the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, Black Diamond may be required to devote additional funds
for investment and lending in its local community. Black Diamond was examined
for CRA compliance in April 1998 and received a rating of "outstanding."
TRANSACTIONS WITH AFFILIATES. Generally, transactions between a savings
association or its subsidiaries and its affiliates are required to be on terms
as favorable to the association as transactions with non-affiliates. In
addition, certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Generally, such loans must be
made on terms substantially the same as for loans to unaffiliated individuals.
However, recent regulations now permit executive officers and directors to
receive loans with the same terms as those widely available to other employees
through benefit or compensation plans, as long as the director or executive
officer is not given preferential treatment compared to the other participating
employees.
FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts). At December 31, 1999, Black Diamond was in compliance with
these reserve requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements that may be imposed by the OTS. See "--Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
FEDERAL HOME LOAN BANK SYSTEM. Black Diamond is a member of the FHLB of
Atlanta, which is one of 12 regional FHLBs, that administers the home financing
credit function of savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the board of directors of the FHLB. These policies
and procedures are subject to the regulation and oversight of the Federal
Housing Finance Board. All advances from the FHLB are required to be fully
secured by sufficient collateral as determined by the FHLB. In addition, all
long-term advances are required to provide funds for residential home financing.
As a member, Black Diamond is required to purchase and maintain stock
in the FHLB of Atlanta. At December 31, 1999, Black Diamond had $705,000 of FHLB
stock, which was in compliance with this requirement. In past years, Black
Diamond has received substantial dividends on its FHLB stock. For the fiscal
year ended December 31, 1999, dividends paid by the FHLB of Atlanta to Black
Diamond totaled approximately $56,000, which constitutes a $9,000 increase over
the amount of dividends
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received in fiscal year 1998. No assurance can be given that such dividends will
continue in the future at such levels.
Under federal law, the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of Black Diamond's FHLB stock may result in a corresponding
reduction in Black Diamond's capital.
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ITEM 2. PROPERTIES
The Company leases or owns 15 banking offices, as shown in the
following table:
LOCATION OWNED OR LEASED ATM(1)(2) YEAR OPENED/PURCHASED
-------- --------------- --------- ---------------------
202 South Main Street
Reidsville, North Carolina.......... Owned (3) X 1910 (4)
1646 Freeway Drive
Reidsville, North Carolina.......... Owned X 1972
202 Turner Drive
Reidsville, North Carolina.......... Owned X 1969
801 South Van Buren Road
Eden, North Carolina................ Owned X 1996
151 North Fieldcrest Road
Eden, North Carolina................ Leased (expires 2008) 1996
605 North Highway Street
Madison, North Carolina............. Owned X 1997
9570 U.S. 29 Business
Ruffin, North Carolina.............. Leased (expires 2004) 1997
2132 New Garden Road
Greensboro, North Carolina.......... Owned X 1997
704 South College Road
Wilmington, North Carolina.......... Leased (expires 2002) X 1997
301 East Fremont Street
Burgaw, North Carolina.............. Leased (expires 2004) X 1999
600 Trent Street
Norton, Virginia ................... Owned 1973
2302 2nd Street
Richlands, Virginia ................ Owned 1977
700 East Morgan Avenue
Pennington Gap, Virginia ........... Owned 1979
440 South Main Street
Harrisonburg, Virginia.............. Owned 1988
624 Chicago Avenue
Harrisonburg, Virginia ............. Leased (expires 2004) 1999
- --------------
(1) Three additional remote ATM's are located in Reidsville, North Carolina
pursuant to leases that expire in 2001 and 2003. Each of the ATM's
situated at a banking office is a drive-up ATM.
(2) Black Diamond owns and operates a network of 34 ATMs located at
non-bank locations such as convenience stores and colleges. This
network generally covers the Norton, Virginia region and surrounding
areas.
(3) Consists of 27,000 square feet in a two story building and includes the
Company's executive offices.
(4) Original office opened in different location in 1910. Current office
opened in 1980.
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ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of operations, the Company is a party
to various legal proceedings. In the opinion of management, there is no
proceeding pending, or to the knowledge of management threatened, in which an
adverse decision could result in a material adverse change in the business or
results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security
holders of the Company during the fourth quarter of the Company's fiscal year
ending December 31, 1999.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
Ernest J. Sewell, age 59, is the President, Chief Executive Officer and
a Director of the Company and FNB Southeast and a Director of Black Diamond. He
assumed his current position on January 26, 1995 after the resignation of
Willard B. Apple, Jr. from those positions on that date. Prior to joining the
Company and FNB Southeast, Mr. Sewell served as Senior Vice President of Branch
Banking and Trust Company, with 26 years of previous banking experience. He is a
member of the Board of Trustees of Annie Penn Memorial Hospital, Reidsville,
North Carolina, and is Chairman of its Investment Committee. Mr. Sewell also
serves on the boards of various charitable organizations in Rockingham County.
R. Michael Hendricks, age 36, is Senior Vice President, Corporate
Administration of FNB Southeast, and a Director of Black Diamond. He joined FNB
Southeast in 1997 as Senior Vice President and City Executive, prior to being
promoted to his current position in December, 1998. He had previously served as
Vice President, Business Services Manager at Branch Banking and Trust Company
and had 11 years banking experience prior to joining FNB Southeast.
Richard L. Powell, age 48, is Senior Vice President, Support Services,
of the Company and FNB Southeast, Assistant Secretary of the Company, and a
Director of Black Diamond. He joined the Company in 1986 as Assistant Vice
President and was promoted to Vice President in 1988 and to Senior Vice
President in 1993.
Michael W. Shelton, age 38, is Senior Vice President, Secretary and
Chief Financial Officer of FNB Southeast and Vice President, Secretary and
Treasurer of the Company, and a Director of Black Diamond. He joined FNB
Southeast in 1996 as Vice President and was promoted to Senior Vice President in
1998. He had previously served as Assistant Vice President at Branch Banking and
Trust Company and had eight years banking experience prior to joining FNB
Southeast.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET PRICES AND DIVIDEND POLICIES
The Company's common stock is traded on The Nasdaq Stock
Market under the symbol "FNBF." The following table shows the high and low sale
prices per share of the Company's common stock on The Nasdaq Stock Market, based
on published financial sources, and the frequency and per share amount of
dividends paid for each of the last two fiscal years.
DIVIDENDS
CALENDAR PERIOD HIGH LOW PAID
- --------------- ---- --- ---------
Quarter ended March 31, 1998 ... $26.00 $23.75 $ 0.07
Quarter ended June 30, 1998 .... 25.50 22.50 0.07
Quarter ended September 30, 1998 25.25 17.75 0.08
Quarter ended December 31, 1998 19.75 16.00 0.08
Quarter ended March 31, 1999 ... $18.50 $16.00 $ 0.08
Quarter ended June 30, 1999 .... 18.00 15.00 0.08
Quarter ended September 30, 1999 16.25 11.56 0.11
Quarter ended December 31, 1999 12.88 10.38 0.19
As of March 10, 2000, there were approximately 2,416
beneficial owners of the Company's common stock, including 1,166 holders of
record of the Company's common stock.
RECENT SALES OF UNREGISTERED SECURITIES
The Company did not sell any securities in the fiscal year
ended December 31, 1999 which were not registered under the Securities Act of
1933, as amended, except that during such fiscal year the Company granted
options to employees and directors to acquire an aggregate of 206,850 shares of
its Common Stock at a weighted average exercise price of $13.38 per share
pursuant to the Company's Omnibus Equity Compensation Plan.
ITEM 6. SELECTED FINANCIAL DATA
The annual selected historical financial data presented below
are derived from the audited consolidated financial statements of the Company.
The financial statements of the Company have been restated to reflect the
acquisition of Black Diamond in a transaction accounted for as a pooling of
interests. As this information is only a summary, you should read it in
conjunction with the historical financial statements (and related notes) of the
Company and notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere herein.
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ITEM 6. SELECTED FINANCIAL DATA - CONTINUED
Table 1. Selected Financial Data
(in thousands, except per share, ratio and other data)
At and For the Year Ended December 31,
-------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ----------- ----------- ----------- -----------
Income Statement Data:
Net interest income $ 20,427 $ 18,378 $ 14,598 $ 12,222 $ 10,626
Provision for loan losses 1,401 1,171 686 707 387
Other income 2,977 3,085 2,146 1,722 1,757
Other expenses 15,193 12,872 10,859 (1) 9,454 7,610
Net income 4,248 5,022 3,514 2,656 3,074
Balance Sheet Data:
Assets $ 588,419 $ 549,746 $ 445,990 $ 322,789 $ 292,608
Loans (2) 413,257 361,677 319,046 229,943 200,149
Allowance for loan losses 4,436 3,452 3,185 2,422 2,105
Deposits 484,242 459,595 384,121 284,875 261,757
Other borrowings 31,500 17,500 28,720 8,650 3,152
Shareholders' equity 50,730 53,631 30,404 27,109 25,516
Per Common Share Data (3):
Net income, basic $ 0.95 $ 1.19 $ 0.98 $ 0.74 $ 0.87
Net income, diluted (4) 0.93 1.13 0.93 0.73 0.86
Cash dividends declared 0.46 0.30 0.27 0.24 0.21
Book value 11.30 11.81 8.43 7.59 7.18
Tangible book value 11.20 11.68 8.24 7.37 7.18
Other Data:
Branch offices 15 14 14 10 9
Full-time employees 189 184 169 130 122
Performance Ratios:
Return on average assets 0.76% 0.97% 0.94% 0.85% 1.10%
Return on average equity 8.45 11.21 12.49 10.22 13.47
Net interest margin (tax equivalent) 3.88 3.78 4.25 4.28 4.20
Dividend payout 47.98 25.37 27.29 31.93 23.95
Efficiency (5) 64.50 59.50 64.00 66.00 59.20
Asset Quality Ratios:
Allowance for loan losses to period end loans 1.07% 0.95% 1.00% 1.05% 1.04%
Allowance for loan losses to period end
non-performing loans (6) 338.00 221.00 123.00 104.00 246.00
Net charge-offs to loans 0.11 0.26 -0.03 0.18 0.06
Non-performing assets to period end loans
and foreclosed property (6) 0.45 0.85 0.91 1.11 0.54
Capital and Liquidity Ratios:
Average equity to average assets 9.06% 8.69% 7.50% 8.32% 8.15%
Leverage 9.30 10.30 7.00 8.30 8.60
Tier-1 risk-based 13.20 15.30 8.90 12.70 13.50
Total risk-based 14.30 16.30 9.90 13.80 14.50
Average loans to average deposits 83.49 79.31 81.50 79.22 75.18
Average loans to average deposits
and borrowings 77.34 74.47 78.12 77.58 72.23
(1) Includes approximately $1.4 million of non-interest expense attributable to
the opening of four new branches in 1997.
(2) Loans net of unearned income, before allowance for losses, and excluding
loans held for sale.
(3) Gives effect of the 1996 stock spilt and the 1997 stock splits.
(4) Assumes the exercise of outstanding options to acquire common stock. See
Note 15 to the Company's consolidated financial statements.
(5) Computed by dividing non-interest expense by the sum of taxable equivalent
net interest income and non-interest income.
(6) Non-performing loans and non-performing assets include loans past due 90
days or more that are still accruing interest.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion provides information about the major
components of the results of operations and financial condition, liquidity and
capital resources of the Company and should be read in conjunction with the
Company's Consolidated Financial Statements and Notes thereto. See also "Forward
Looking Statements" on page 73 of this Annual Report on Form 10-K.
OVERVIEW
The Company continued strong growth in assets and deposits,
with growth in existing markets aided by favorable economic and market
conditions. The Company also acquired Black Diamond Savings Bank, headquartered
in Norton, Virginia, a transaction that added approximately $135 million in
assets at the closing date of August 31, 1999. The acquisition was accounted for
as a pooling of interests, and all financial statements and other data have been
restated to reflect this business combination.
As a result of the Black Diamond merger, FNB Financial
Services Corporation is now a North Carolina bank holding company with
consolidated assets of $588.4 million at December 31, 1999. The Company, through
its two subsidiaries, FNB Southeast, a North Carolina chartered commercial bank,
and Black Diamond Savings Bank, a federally chartered savings bank, currently
operates fifteen banking offices in North Carolina and Virginia. On March 15,
2000 the Company filed an application with the Office of the Commission of Banks
for the State of North Carolina to merge Black Diamond into FNB Southeast. The
effect of the merger, if approved, would be to operate Black Diamond locations
as branches of FNB Southeast.
During the year, both FNB Southeast and Black Diamond (the
"Subsidiary Banks") expanded their banking networks. FNB Southeast opened an
office in Burgaw, North Carolina, and has two offices in Greensboro, North
Carolina under construction. These two offices are expected to open early in the
second quarter of 2000 and complement our existing branch in that market. Black
Diamond opened a second Harrisonburg, Virginia office in the third quarter of
1999 to capitalize on its existing presence in this growing market. Both banks
continue to look at additional markets and sites for future expansion of their
franchises.
RESULTS OF OPERATIONS
Net income for the full year totaled $4.25 million, or $0.93
in diluted earnings per share, and is inclusive of approximately $972,000 in
after-tax merger related expenses and other charges in connection with the
acquisition of Black Diamond. Pro forma annual net income excluding these
one-time charges totaled $5.22 million, or $1.15 in diluted earnings per share,
and represents a 3.9% increase over restated net income of $5.02 million in
1998.
Non-interest expenses of $15.2 million was 18.0% higher than
the prior year and included $675,000 in merger related cost such as fees for
investment bankers, attorneys, accountants, printers and other charges.
Recurring expenses excluding these one-time expense items was $14.5 million, a
12.8% increase from 1998 levels.
The Company's primary source of income is net interest income,
which is the difference between (i) interest income and fees derived from
earning assets (primarily loans and investment securities) and (ii) the cost of
funds (primarily deposits and other borrowings) supporting them.
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Net interest income represents the gross profit from the
lending and investment activities of a banking organization and is the most
significant factor affecting the earnings of the Company. Net interest income is
influenced by changes in interest rates, volume and the mix of these various
components. Net interest income on a fully taxable equivalent basis was $20.6
million, which represented a 10.9% increase over the previous year. In 1998,
taxable equivalent net interest income increased to approximately $18.6 million
from approximately $14.9 million in 1997, which was an increase of 26.4%. Actual
net interest income was 11.2% higher in 1999, following an improvement of 25.9%
in 1998. Growth in net interest income for 1999 was occasioned by higher loan
balances and improved net interest margins, supported by deposit growth and
increased borrowing from the Federal Home Loan Bank of Atlanta. Average loans
outstanding during the year equaled $387.3 million compared to $347.3 million in
1998, an increase of 11.5%. In the previous year, average loans outstanding were
29.5% higher than 1997. This loan growth is attributed to generally favorable
economic conditions in the Company's lending markets and the addition of
commercial loan officers in selected markets. Average investment securities
during 1999 were $136.5 million, down 1.6% over 1998, following a substantial
increase of 86.3% the previous year. Average total deposits of $463.9 million
were up 5.9% in 1999, which followed a gain of 33.1% the previous year. Average
shareholders' equity balances of $50.3 million represented a 12.2% increase over
1998.
Overall trends in interest rates continued lower for the full
year. Although the earning asset yield declined, the rate paid on
interest-bearing liabilities experienced a steeper decline, allowing for
improved net interest margins for 1999. The weighted average yield on earning
assets fell to 8.05%, from 8.26% in 1998, a decrease of 21 basis points. This is
primarily due to the current yield on loans dropping 29 basis points to 8.87% in
1999, compared to a yield of 9.16% in 1998.
The weighted average rate paid on interest bearing liabilities
decreased to 4.86% in 1999, from 5.17% last year. Consequently, the interest
rate spread rose to 3.19% in 1999, from 3.09% the previous year. The prime rate
on loans was increased from 7.75% to 8.50% during the second half of 1999. The
rate increase came too late in the year to prevent the weighted rate on loans
from falling to 8.87% in 1999 compared to 9.16% in 1998. Investment securities
yields were 6.12% on a taxable equivalent basis in 1999, down from 6.28% last
year. The weighted average rate paid on savings and time deposits decreased from
5.15% in 1998 to 4.83% this year, as depositors renewed maturing certificates at
lower rates and increased balances in relatively lower cost money market
instruments.
Table 2 on page 33 summarizes net interest income and average
yields earned and rates paid for the years indicated, on a tax equivalent basis.
Table 3 on page 34 presents the changes in interest income and interest expense
attributable to volume and rate changes between 1999 and 1998, and between 1998
and 1997.
NON-INTEREST INCOME AND EXPENSE
Non-interest income of $2.98 million in 1999 was $108,000 or
0.04% less than the previous year. Service charges on deposit accounts increased
to $1.79 million, up 25.1% from $1.43 million in 1998. The Company was able to
capitalize on increased fees and increased volume of demand deposits and other
accounts with service charges.
Two categories of non-interest income, gain on sale of
securities and gain on sale of loans, experienced significant declines in 1999
compared to 1998 due to changes in the interest rate environment during the
year. Gains on sale of securities for 1999 totaled $118,000, down $304,000 from
the prior year. Gain on sale of loans for 1999 totaled $174,000, down $160,000
from one year earlier.
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Both of these categories were negatively impacted by the trend of rising
interest rates over the second half of 1999. In 1999, the Company recorded
$521,000 in bankcard fee revenue. Due to the sale of the credit card portfolio
and the merchant account program, these revenues will decline significantly in
2000.
Recurring non-interest expense, excluding the $675,000 in
merger related costs, increased $1.65 million, or 12.8%, in 1999 to $14.52
million, compared to $12.87 million in 1998. Last year, non-interest expense of
$12.87 million exceeded the previous year by $2.01 million, or 18.5%. The
primary reasons for the increase in expense in 1999 have been the full year
effect of depreciation on the personal computer network installed in 1998, and
fees for internal audit services that were outsourced during 1999.
Personnel expense of $8.17 million in 1999 exceeded the
previous year by $800,000, or 10.8%. Total salaries of officers and staff of
$6.58 million were $454,000 or 7.4% more than 1998. At December 31, 1999, the
Company had approximately 182 full-time and 13 part-time employees, compared
with approximately 177 full-time and 15 part-time employees at December 31,
1998. Occupancy expense followed a 13.4% increase in expense in 1998 with an
additional 10.8% in 1999, or $771,000 for the full year. Furniture and equipment
expense totaled $1.28 million in the current year, up $334,000 or 35.3%,
following a 31.0% increase in 1998 over 1997. Depreciation on equipment of
$764,000 this year was up 28.2% over 1998, while equipment rent and personal
property taxes posted higher numbers in 1999. All other expenses of $3.08
million were up $415,000, or 15.6% over 1998. In 1999, the Company recorded
$412,000 in bankcard processing expense. Due to the sale of the credit card
portfolio and the merchant account program, these expenses will decline
significantly in 2000.
The efficiency ratio, which measures non-interest expense as a
percentage of net interest income plus non-interest income, was 64.5% in 1999,
and compared unfavorably to 59.5% posted the previous year. Excluding $675,000
of merger related cost, the pro forma efficiency ratio for 1999 was 61.6%.
The Company experienced a higher effective tax rate during
1999. The increased effective tax rate for 1999 is primarily attributable to tax
treatment of merger related cost recognized in the third quarter of 1999.
Secondly, the effective tax rate for 1998 was lowered because the Company had
minimum state taxes due to increased investment tax-exempt income as a
percentage of interest income. This had the effect of decreasing the tax rate
for 1998.
FINANCIAL CONDITION
The Company's consolidated assets of $588.4 million at year
end increased 7.0% over the previous year, following an increase of 23.3% in
1998. Growth in earning assets in 1998 occurred in both loans and investment
securities, while 1999 saw a marked increase in outstanding loans. Supporting
that growth this year were increases of 6.6% in non-interest bearing deposits,
5.2% in interest bearing deposits and 80.0% in other borrowings.
Loan growth during 1999 was $51.8 million, with outstanding
loans up 14.3% at year end, following increases of 13.2% in 1998 and 38.6% in
1997. Loans secured by real estate were up 14.7% and represented 67.9% of total
loans, compared with 67.6% at year end 1998. Within the category, commercial
real estate loans increased 21.8%, to a level of $115.4 million. Commercial,
financial and agricultural loans were up 16.4% representing 14.0% of total
loans, compared with 13.8% last year end. Consumer loans advanced 11.1% led
mainly by increases in home equity loans. Management believes the Company is not
dependent on any single customer or group of customers concentrated in a
particular industry, the loss of whose deposits or whose insolvency would have a
material adverse effect on operations.
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Investment securities (at amortized cost) of $136.7 million at
year end were down $18.4 million or 11.9% over 1998. U. S. Government agency
securities continue to represent the major share of the total portfolio,
although decreasing from 84.1% of the portfolio at the end of 1998 to 81.6% at
year end 1999. Management believes that the additional risk of owning Agencies
over U. S. Treasury securities is negligible and has capitalized on the
favorable spreads available on the former. For the first time in two years the
Company was able to purchase tax-exempt municipal securities in the latter part
of 1999. The pricing in these securities turned favorable and will serve to
boost total returns in future periods. The Company's investment portfolio goals
are to achieve good total portfolio returns, within the context of remaining
relatively short in maturity to fund loan growth and mitigate the unfavorable
effect of interest rate increases. To this end, the Company has consistently
categorized the entire portfolio as Available for Sale, which it believes offers
the greatest amount of flexibility in managing a total return concept. Table 4
on page 35 presents the composition of the securities portfolio for the last
three years, as well as information about cost, fair value and weighted average
yield.
During the first half of 1999, deposits rates trended downward
in response to the decreases in interest rates precipitated by the Federal
Reserve Bank reducing short term interest rates in late 1998. This scenario
provided little incentive for customers to choose longer term deposit at a
minimal spread difference from shorter, more liquid products. Accordingly,
retail deposit growth was concentrated in money market investment accounts,
which have superior liquidity compared to a certificate of deposit while
providing a competitive return to depositors. The market for deposits remains
fiercely competitive and the Company relies on appropriate pricing and quality
customer service to retain and increase its retail deposit base. For commercial
customers, the Company is focused on building a total relationship, which will
foster growth in both loans and deposits. In addition to traditional regular
checking accounts, the Company offers a cash management sweep account, with
outstanding balances decreasing from $10.4 million at the end of 1998 to $7.5
million in 1999.
In order to attract longer term deposits, the Company
maintains membership in an electronic network which allows it to post interest
rates and attract deposits nationally. As of December 31, 1999, the Company had
approximately 165 certificates of deposit totaling $16.2 million, with an
overall rate of 5.74% for the total portfolio. This certificate portfolio has
increased by $4.6 million during 1999. Overall, the certificates booked during
1999 were at lower rates than certificates booked during 1998. As a result, the
portfolio rate declined from 5.91% at December 31, 1998 to 5.86% at December 31
1999. The primary focus of this funding source has been to provide longer-term
deposits to offset the demand for short-term retail deposits. However, current
deposit rates in this market are trending upward and this may result in a higher
overall rate on this certificate portfolio in the future if new deposits are
booked.
The Company also utilized a portion of its $88.5 million line
with the FHLB of Atlanta to fund earning assets, with a year end balance
outstanding of $31.5 million. Management continues to believe this is a cost
effective and prudent alternative to deposit balances, since a particular amount
and term may be selected to meet its current needs.
ASSET QUALITY
Management believes that asset quality is of great importance.
The allowance for loan losses, which is utilized to absorb actual losses in the
loan portfolio, is maintained at a level sufficient to provide for estimated
probable charge-offs of non-collectible loans. The loan portfolio is analyzed
periodically in an effort to identify potential problems before they actually
occur. The Company's allowance for loan losses is also analyzed quarterly by
management. This analysis includes a methodology that segments the loan
portfolio by selected loan types and considers the current status of the
portfolio, historical charge-off experience, current levels of delinquent,
impaired and non-performing
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loans, as well as economic and inherent risk factors. The provision for loan
losses represents a charge against income in an amount necessary to maintain the
allowance at an appropriate level. The monthly provision for loan losses may
fluctuate based on the results of this analysis. Table 6 on page 37 depicts a
summary of the allowance for loan losses and the allocation of the allowance for
loan losses for the years ended December 31, 1995 through 1999. The allocation
is based on management's grading of the loan portfolio with the remaining
portion allocated to the general category, although the entire allowance is
available to be used for write-offs in any category.
The 1999 provision of $1.40 million compares with $1.17
million in 1998 and $686,000 in 1997, which equals a 19.6% increase in 1999. The
1999 total provision includes a one-time increase of $465,000 charged against
income during the third quarter to conform the policies of Black Diamond to
those of FNB Southeast. Credit quality continued strong and the level of
non-performing loans and charge-offs has remained comparatively low. Net
charge-offs decreased in 1999 to a level of $417,000 or 0.11% of average loans
outstanding, compared with $703,000 the prior year and net recoveries of $77,000
in 1997. Approximately 59% of the net charge-offs in 1998 were for two
commercial loans. At December 31, 1999, the allowance for loan losses as a
percentage of year end loans was 1.07%, which represented an increase from 0.95%
at December 31, 1998.
At December 31, 1999 and 1998, the recorded investment in
loans that were considered impaired was approximately $1,747,000 and $1,474,000,
respectively. The related allowance for loan losses on these impaired loans was
approximately $488,000 and $60,000, respectively. The average recorded
investment in impaired loans for the years ended December 31, 1999 and 1998 was
approximately $1,611,000 and $1,987,000 respectively. There were no loans on
nonaccrual status that were not considered impaired at December 31, 1999.
Non-performing assets include non-accrual loans, accruing
loans contractually past due 90 days or more, restructured loans, other real
estate and other real estate under contract for sale. Loans are placed on
non-accrual status when management has concerns relating to the ability to
collect the loan principal and interest and generally when such loans are 90
days or more past due. While non-performing assets represent potential losses to
the Company, management does not anticipate any aggregate material losses, since
most loans are believed to be adequately secured. Management believes the
allowance for loan losses is sufficient to absorb known risks in the portfolio.
No assurance can be given, however, that economic conditions will not adversely
affect borrowers and result in increased losses.
CAPITAL RESOURCES
Banks and bank holding companies, as regulated institutions,
must meet required levels of capital. The Federal Reserve has adopted minimum
capital regulations or guidelines that categorize components and the level of
risk associated with various types of assets. Financial institutions are
required to maintain a level of capital commensurate with the risk profile
assigned to its assets in accordance with the guidelines. As shown in Table 7 on
Page 38, in 1999 and 1998 the Company and both Subsidiary Banks maintained
capital levels exceeding the minimum levels for "well capitalized" banks and
bank holding companies. Because of significant growth realized in 1997, the
levels fell to "adequately capitalized" by the end of 1997. Capital levels were
dramatically increased in 1998 when the Company sold a total of 897,000
additional shares in a public offering during April and May 1998, generating
approximately $18.5 million in new capital. The result of this capital infusion
was to restore the Company and FNB Southeast to "well capitalized" status at the
end of 1998. Effective in March 1999, FNB Southeast converted from a national
bank, regulated by the OCC, to a North Carolina
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bank, regulated by the North Carolina Commissioner of Banks ("Commissioner").
FNB Southeast will continue to be required to meet certain levels of capital.
INTEREST RATE SENSITIVITY AND LIQUIDITY MANAGEMENT
A primary objective of interest rate sensitivity management is
to ensure the stability and quality of the Company's primary earning component,
net interest income. This process involves monitoring the Company's balance
sheet in order to determine the potential impact that changes in the interest
rate environment would have on net interest income. Rate sensitive assets and
liabilities have interest rates which are subject to change within a specific
time period, due to either maturity or to contractual agreements which allow the
instruments to reprice prior to maturity. Interest rate sensitivity management
seeks to ensure that both assets and liabilities react to changes in interest
rates within a similar time period, thereby minimizing the risk to net interest
income.
The measurement of the Company's interest rate sensitivity, or
"gap" is a technique traditionally used in asset/liability management. The
interest sensitivity gap is the difference between repricing assets and
repricing liabilities for a particular time period. Table 8 on page 39 indicates
a ratio of rate sensitive assets to rate sensitive liabilities within one year
at December 31, 1999 to be 81%. This ratio indicates that net interest income
would decline in a rising interest rate environment, since a greater amount of
liabilities than assets would reprice more quickly over the one-year period.
Included in rate sensitive liabilities are certain deposit accounts (NOW, MMI
and savings) that are subject to immediate withdrawal and repricing, yet have no
stated maturity. These balances are presented in the category that management
believes best identifies their actual repricing patterns. This analysis assumes
60% of NOW and MMI accounts, and 20% of savings accounts reprice within one year
and the remaining balances reprice after one year. Furthermore, the overall risk
to net interest income is further mitigated by the Company's level of variable
rate loans. These are loans with a contractual interest rate tied to an index,
such as the prime rate. A portion of these loans may reprice on multiple
occasions during a one-year period due to changes in the underlying rate index.
Approximately 52% of the total loan portfolio has variable rates, and reprices
in accordance with the underlying rate index subject to terms of individual note
agreements.
In addition to the traditional gap analysis, the Company also
utilizes a computer based interest rate risk simulation model. This
comprehensive model includes rate sensitivity gap analysis, rate shock net
interest margin analysis, and asset/liability term and rate analysis. The
Company uses this model to monitor interest rate risk on a quarterly basis and
to detect trends that may affect the overall net interest income for the
Company. This simulation incorporates the dynamics of balance sheet and interest
rate changes and reflects the related effect on net interest income. As a
result, this analysis more accurately projects the risk to net interest income
over the upcoming twelve-month period. The