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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
Commission file number 0-24159
MIDDLEBURG FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Virginia 54-1696103
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
111 West Washington Street
Middleburg, Virginia 20117
(Address of Principal Executive Offices) (Zip Code)
(703) 777-6327
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
None n/a
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $5.00 per share
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 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 past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes ___ No _X__
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and asked price of such common
equity, as of the last business day of the registrant's most recently completed
second fiscal quarter. $61,170,310
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. 1,852,682 shares of
Common Stock
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 2003 Annual Meeting of Shareholders - Part III
TABLE OF CONTENTS
PART I
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Page
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ITEM 1. BUSINESS.............................................................3
ITEM 2. PROPERTIES...........................................................7
ITEM 3. LEGAL PROCEEDINGS....................................................8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS...............................................9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.......................................9
ITEM 6. SELECTED FINANCIAL DATA.............................................10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................11
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK......................................................36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........................38
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE...........................38
PART III
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ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS....................................38
ITEM 11. EXECUTIVE COMPENSATION..............................................38
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS..............................................38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................39
ITEM 14. CONTROLS AND PROCEDURES.............................................39
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K..............................................40
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PART I
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ITEM 1. BUSINESS
General
Middleburg Financial Corporation ("MFC" or the "Company") is a bank
holding company that was incorporated under Virginia law in 1993. The Company
changed its name in May 2002 from Independent Community Bankshares, Inc. to
Middleburg Financial Corporation. The Company conducts its primary operations
through three wholly owned subsidiaries, Middleburg Bank (the "Bank"), Tredegar
Trust Company ("Tredegar") both of which are chartered under Virginia law, and
Gilkison Patterson Investment Advisors, Inc. ("GPIA"), which is an investment
advisor registered with the Securities and Exchange Commission.
The Bank has five full service branches and one limited service
facility. The Bank has its main office at 111 West Washington Street,
Middleburg, Virginia 20117, and has offices in Purcellville, Leesburg and
Ashburn, Virginia. The Bank opened for business on July 1, 1924.
Tredegar has its main office at 821 East Main Street, Richmond,
Virginia 23219, and a branch office in Middleburg, Virginia. Tredegar opened for
business in January 1994.
GPIA has its main office at 1901 North Beauregard Street, Alexandria,
Virginia 22311.
The Bank serves western Loudoun County. Loudoun County is in
northwestern Virginia and included in the Washington-Baltimore Metropolitan
statistical area. Loudoun County's population is approximately 170,000 with over
one-third of the population located in the Company's markets. The local economy
is driven by service industries requiring a high skill level, self-employed
individuals, the equine industry and the independently wealthy. Tredegar serves
primarily the greater Richmond area including the counties of Henrico,
Chesterfield, Hanover, Goochland and Powhatan, as well as Loudoun County.
However, Tredegar does have clients outside of its primary market. Richmond is
the state capital of Virginia, and the greater Richmond area has a population in
excess of 800,000 people. GPIA primarily serves the District of Columbia
metropolitan area including contingent markets in Virginia and Maryland but also
has clients in 25 other states.
The Company, through its subsidiaries, offers a wide range of banking,
fiduciary and investment management services available to both individuals and
small businesses. The banking services include various types of checking and
savings deposit accounts, and the making of business, real estate, development,
mortgage, home equity, automobile and other installment, demand and term loans.
Also, the Bank offers ATMs at all locations, internet banking, travelers'
checks, money orders, safe deposit rentals, collections, notary public, wire
services and other traditional bank services to its customers. Tredegar provides
a variety of investment management and fiduciary services including trust and
estate settlement. Tredegar can also serve as escrow agent, attorney-in-fact,
guardian of property or trustee of an IRA. GPIA provides fee based investment
management services for its clients.
The Bank has one wholly owned subsidiary, Middleburg Bank Service
Corporation. Middleburg Bank Service Corporation is a partner in a limited
liability company, Bankers Title Shenandoah, LLC, which sells title insurance to
its members. Middleburg Bank Service Corporation has also invested in another
limited liability company, Virginia Bankers Insurance Center, LLC, which acts as
a broker for insurance sales for its member banks. The Company has a fourth
wholly owned subsidiary, ICBI Capital Trust I, which is a Delaware Business
Trust that the Company formed in connection with the issuance of $10 million in
trust preferred debt in November 2001.
-3-
As of December 31, 2002, the Company had a total of 152 full time
equivalent employees. The Company considers relations with its employees to be
excellent. The Company's employees are not represented by a collective
bargaining unit.
Competition
The Company faces significant competition for both loans and deposits.
Competition for loans comes from commercial banks, savings and loan associations
and savings banks, mortgage banking subsidiaries of regional commercial banks,
subsidiaries of national mortgage bankers, insurance companies, and other
institutional lenders. Its most direct competition for deposits has historically
come from savings and loan associations and savings banks, commercial banks,
credit unions and other financial institutions. Based upon total deposits at
June 30, 2002 as reported to the FDIC, MFC has the largest share of deposits
among the banking organizations operating in Loudoun County, Virginia. MFC also
faces competition for deposits from short-term money market mutual funds and
other corporate and government securities funds.
Tredegar competes for clients and accounts with banks, other financial
institutions and money managers. Even though many of these institutions have
been engaged in the trust or investment management business for a considerably
longer period of time than Tredegar and have significantly greater resources,
Tredegar has grown through its commitment to quality trust services and a local
community approach to business.
GPIA competes for its clients and accounts with other money managers
and investment brokerage firms. Like the rest of the Company, GPIA is dedicated
to quality service and high investment performance for its clients. GPIA has
successfully operated in its markets for 21 years. For 19 years, GPIA operated
under the name of Kahn Brothers Investment Management Company ("KBIMC"). Upon
entering into a purchase option with MFC, KBIMC changed its name to "Gilkison
Patterson Investment Advisors, Inc."
Supervision and Regulation
General. As a bank holding company, the Company is subject to
regulation under the Bank Holding Company Act of 1956, as amended, (the "BHCA")
and the examination and reporting requirements of the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board"). Under the BHCA, a bank
holding company may not directly or indirectly acquire ownership or control of
more than 5% of the voting shares or substantially all of the assets of any bank
or merge or consolidate with another bank holding company without the prior
approval of the Federal Reserve Board. The BHCA also generally limits the
activities of a bank holding company to that of banking, managing or controlling
banks, or any other activity that is determined to be so closely related to
banking or to managing or controlling banks that an exception is allowed for
those activities.
As a state-chartered commercial bank, the Bank is subject to
regulation, supervision and examination by the Virginia State Corporation
Commission's Bureau of Financial Institutions. It is also subject to regulation,
supervision and examination by the Federal Reserve Board. State and federal law
also governs the activities in which the Bank engages, the investments that it
makes and the aggregate amount of loans that may be granted to one borrower.
Various consumer and compliance laws and regulations also affect the Bank's
operations.
The earnings of the Company's subsidiaries, and therefore the earnings
of the Company, are affected by general economic conditions, management
policies, changes in state and federal legislation and actions of various
regulatory authorities, including those referred to above. The following
description
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summarizes the significant federal and state laws to which the Company, the Bank
and Tredegar are subject. To the extent statutory or regulatory provisions or
proposals are described, the description is qualified in its entirety by
reference to the particular statutory or regulatory provisions or proposals.
Payment of Dividends. The Company is a legal entity separate and
distinct from its banking and other subsidiaries. The majority of the Company's
revenues are from dividends paid to the Company by the Bank. The Bank is subject
to laws and regulations that limit the amount of dividends it can pay. In
addition, both the Company and the Bank are subject to various regulatory
restrictions relating to the payment of dividends, including requirements to
maintain capital at or above regulatory minimums. Banking regulators have
indicated that banking organizations should generally pay dividends only if the
organization's net income available to common shareholders over the past year
has been sufficient to fully fund the dividends and the prospective rate of
earnings retention appears consistent with the organization's capital needs,
asset quality and overall financial condition. The Company does not expect that
any of these laws, regulations or policies will materially affect the ability of
the Bank to pay dividends. During the year ended December 31, 2002, the Bank
declared $2.1 million in dividends payable to the Company.
Capital. The Federal Reserve Board has issued risk-based and leverage
capital guidelines applicable to banking organizations that it supervises. Under
the risk-based capital requirements, the Company and the Bank are each generally
required to maintain a minimum ratio of total capital to risk-weighted assets
(including certain off-balance sheet activities, such as standby letters of
credit) of 8%. At least half of the total capital must be composed of common
equity, retained earnings and qualifying perpetual preferred stock, less certain
intangibles ("Tier 1 capital"). The remainder may consist of certain
subordinated debt, certain hybrid capital instruments, qualifying preferred
stock and a limited amount of the loan loss allowance ("Tier 2 capital," which,
together with Tier 1 capital, composes "total capital").
In addition, each of the federal banking regulatory agencies has
established minimum leverage capital requirements for banking organizations.
Pursuant to these requirements, banking organizations must maintain a minimum
ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%
subject to federal banking regulatory evaluation of an organization's overall
safety and soundness.
The risk-based capital or standards of the Federal Reserve Board
explicitly identify concentrations of credit risk and the risk arising from
non-traditional activities, as well as an institution's ability to manage these
risks, as important factors to be taken into account by the agency in assessing
an institution's overall capital adequacy. The capital guidelines also provide
that an institution's exposure to a decline in the economic value of its capital
due to changes in interest rates be considered by the agency as a factor in
evaluating a banking organization's capital adequacy.
Other Safety and Soundness Regulations. There are a number of
obligations and restrictions imposed on bank holding companies and their
depository institution subsidiaries by federal law and regulatory policy that
are designed to reduce potential loss exposure to the depositors of such
depository institutions and to the Federal Deposit Insurance Corporation
("FDIC") insurance funds in the event that the depository institution is
insolvent or is in danger of becoming insolvent. For example, under requirements
of the Federal Reserve Board with respect to bank holding company operations, a
bank holding company is required to serve as a source of financial strength to
its subsidiary depository institutions and to commit resources to support such
institutions in circumstances where it might not do so otherwise. In addition,
the "cross-guarantee" provisions of federal law require insured depository
institutions under common control to reimburse the FDIC for any loss suffered or
reasonably anticipated by the FDIC as a result of the insolvency of commonly
controlled insured depository institutions or for any assistance provided by the
FDIC to commonly controlled insured depository institutions in danger of
failure. The FDIC may decline to enforce the cross-guarantee provision if it
determines that a waiver is in
-5-
the best interests of the deposit insurance funds. The FDIC's claim for
reimbursement under the cross guarantee provisions is superior to claims of
shareholders of the insured depository institution or its holding company but is
subordinate to claims of depositors, secured creditors and nonaffiliated holders
of subordinated debt of the commonly controlled insured depository institutions.
The federal banking agencies also have broad powers under current
federal law to take prompt corrective action to resolve problems of insured
depository institutions. The extent of these powers depends upon whether the
institution in question is well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized or critically undercapitalized,
as defined by the law. As of December 31, 2002, the Company and the Bank were
classified as well capitalized.
State banking regulators also have broad enforcement powers over the
Bank, including the power to impose fines and other civil and criminal
penalties, and to appoint a conservator.
Interstate Banking and Branching. Current federal law authorizes
interstate acquisitions of banks and bank holding companies without geographic
limitation. Effective June 1, 1997, a bank headquartered in one state was
authorized to merge with a bank headquartered in another state, as long as
neither of the states had opted out of such interstate merger authority prior to
such date. After a bank has established branches in a state through an
interstate merger transaction, the bank may establish and acquire additional
branches at any location in the state where a bank headquartered in that state
could have established or acquired branches under applicable federal or state
law.
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 (the
"Act") was signed into law on November 12, 1999. The Act covers a broad range of
issues, including a repeal of most of the restrictions on affiliations among
depository institutions, securities firms and insurance companies. Most of the
Act's provisions require the federal banking regulatory agencies and other
regulatory bodies to adopt regulations to implement the Act, and for that reason
an assessment of the full impact on the Company of the Act must await completion
of that regulatory process.
The Act repeals sections 20 and 32 of the Glass-Stegall Act, thus
permitting unrestricted affiliations between banks and securities firms. The Act
also permits bank holding companies to elect to become financial holding
companies. A financial holding company may engage in or acquire companies that
engage in a broad range of financial services, including securities activities
such as underwriting, dealing, brokerage, investment and merchant banking,
insurance underwriting, sales and brokerage activities. In order to become a
financial holding company, the bank holding company and all of its affiliated
depository institutions must be well-capitalized, well-managed, and have at
least a satisfactory Community Reinvestment Act rating.
The Act provides that the states continue to have the authority to
regulate insurance activities but prohibits the states in most instances from
preventing or significantly interfering with the ability of a bank, directly or
through an affiliate, to engage in insurance sales, solicitations or
cross-marketing activities. Although the states generally must regulate bank
insurance activities in a nondiscriminatory manner, the states may continue to
adopt and enforce rules that specifically regulate bank insurance activities in
certain areas identified in the Act. The Act directs the federal banking
regulatory agencies to adopt insurance consumer protection regulations that
apply to sales practices, solicitations, advertising and disclosures.
The Act adopts a system of functional regulation under which the
Federal Reserve Board is confirmed as the umbrella regulator for financial
holding companies, but financial holding company affiliates are to be
principally regulated by functional regulators such as the FDIC for state
nonmember bank affiliates, the Securities and Exchange Commission for securities
affiliates and state insurance
-6-
regulators for insurance affiliates. The Act repeals the broad exemption of
banks from the definitions of "broker" and "dealer" for purposes of the
Securities Exchange Act of 1934, as amended, but identifies a set of specific
activities, including traditional bank trust and fiduciary activities, in which
a bank may engage without being deemed a "broker", and a set of activities in
which a bank may engage without being deemed a "dealer". The Act also makes
conforming changes in the definitions of "broker" and "dealer" for purposes of
the Investment Company Act of 1940, as amended, and the Investment Advisers Act
of 1940, as amended.
The Act contains extensive customer privacy protection provisions.
Under these provisions, a financial institution must provide to its customers,
at the inception of the customer relationship and annually thereafter, the
institution's policies and procedures regarding the handling of customers'
nonpublic personal financial information. The Act provides that, except for
certain limited exceptions, an institution may not provide such personal
information to unaffiliated third parties unless the institution discloses to
the customer that such information may be so provided and the customer is given
the opportunity to opt out of such disclosure. An institution may not disclose
to a non-affiliated third party, other than to a consumer reporting agency,
customer account numbers or other similar account identifiers for marketing
purposes. The Act also provides that the states may adopt customer privacy
protections that are more strict than those contained in the Act. The Act also
makes a criminal offense, except in limited circumstances, obtaining or
attempting to obtain customer information of a financial nature by fraudulent or
deceptive means.
Tredegar. Tredegar operates as a trust subsidiary of the Company. It is
subject to supervision and regulation by the Virginia State Corporation
Commission's Bureau of Financial Institutions and the Federal Reserve Board.
State and federal regulators have substantial discretion and latitude
in the exercise of their supervisory and regulatory authority over Tredegar,
including the statutory authority to promulgate regulations affecting the
conduct of business and the operations of Tredegar. They also have the ability
to exercise substantial remedial powers with respect to Tredegar in the event
that it determines that Tredegar is not in compliance with applicable laws,
orders or regulations governing its operations, is operating in an unsafe or
unsound manner, or is engaging in any irregular practices.
GPIA. GPIA operates as a non-banking subsidiary of the Company. It is
subject to supervision and regulation by the Securities and Exchange Commission
under the Investment Advisors Act of 1940, as amended.
ITEM 2. PROPERTIES
The headquarters building of the Company and the Bank, which also
serves as a branch office for Tredegar, was completed in 1981 and is a two-story
building of brick construction, with approximately 18,000 square feet of floor
space, located at 111 West Washington Street, Middleburg, Virginia 20117. The
office operates nine teller windows, including three drive-up facilities and one
stand-alone automatic teller machine. The Bank owns the headquarters building.
The Purcellville bank branch was purchased in 1994 and is a one-story
building with a basement of brick construction, with approximately 3,000 square
feet of floor space, located at 431 East Main Street, Purcellville, Virginia
20132. The office operates four teller windows, including three drive-up
facilities and one drive-up automatic teller machine. The Bank owns this branch
building.
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The Catoctin Circle, Leesburg bank branch was completed in 1997 and is
a two-story building of brick construction, with approximately 6,000 square feet
of floor space, located at 102 Catoctin Circle, SE, Leesburg, Virginia 20175.
The office operates five teller windows, including three drive-up facilities and
one drive-up automatic teller machine. The Bank owns this branch building.
The Fort Evans Road, Leesburg bank branch was completed in July 2002
and is a one-story building of brick construction, with approximately 3,500
square feet of floor space, located at 211 Fort Evans Road, NE, Leesburg,
Virginia 20176. The office operates five teller windows, including three
drive-up facilities and one drive-up automatic teller machine. The Bank owns
this branch building.
The Leesburg limited service facility, located at 200 North King
Street, was leased beginning April 1999. The leased space consists of 200 square
feet with one teller window and a stand-alone automated teller machine.
Transactions in this branch are limited to paying and receiving teller
functions. The initial term of this lease is five years with two additional
renewal periods of five years each. The annual lease expense associated with
this location is $5,400.
The Ashburn bank branch, which is leased, opened in June 1999 and
consists of 3,400 rentable square feet at 20955 Professional Plaza, Suite 100,
Ashburn, Virginia 20147. The office is a full service branch with five teller
windows, three drive-up facilities and a drive-up automated teller machine. The
initial term of the lease is 15 years with two five-year renewal options. The
annual lease expense associated with this location is $68,000.
The Leesburg operations building was completed in June 2002. The
building is Class A office space and is home to the deposit and loan operations,
data processing, information technology, human resources, training and mortgage
banking departments. This building is a two story building with 18,000 square
feet of floor space, located at 106 Catoctin Circle, SE, Leesburg, Virginia
20175. The Bank owns this building.
Tredegar leases its main office at 821 East Main Street in Richmond,
Virginia. The lease, which was entered into in August 2001 when Tredegar moved
from its former location, is for a term of 15 years, with no renewal options.
The annual lease expense for the new location will be $165,000. Total lease
expense for 2001, including the new and previous office space, was $76,000.
Tredegar closed its branch office in Williamsburg, Virginia in April 2001. The
space included approximately 500 square feet used primarily for business
development and sales. The annual lease expense associated with this location
was $7,500.
GPIA leases its main office at 1901 North Beauregard Avenue,
Alexandria, Virginia, 22311. The lease, which was entered into in May 1999, is
for a term of five years, with no renewal options. The space includes
approximately 3,500 square feet of office space and 900 square feet of storage.
The annual lease expense associated with this location is $79,000. The lease is
currently in negotiations with no anticipated increase in expense.
All of the Company's properties are in good operating condition and are
adequate for the Company's present and anticipated future needs.
ITEM 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the company is
a party or of which the property of the Company is subject.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the fiscal year
covered by this report to a vote of security holders of the Company.
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since May 15, 2002, the Company's Common Stock has traded on the Nasdaq
SmallCap Market under the symbol "MBRG". From September 15, 2000 until May 14,
2002, the Company's Common Stock had traded on the Nasdaq SmallCap Market under
the symbol "ICBX".
Market Price and Dividends
Sales Price ($) Dividends ($)
--------------- -------------
High Low
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2001:
1st quarter............................ 33.00 21.00 .25
2nd quarter............................ 31.25 27.00 .25
3rd quarter............................ 36.00 29.00 .25
4th quarter............................ 35.90 32.50 .25
2002:
1st quarter............................ 45.58 35.11 .30
2nd quarter............................ 50.00 44.10 .30
3rd quarter............................ 48.75 44.00 .30
4th quarter............................ 48.25 45.25 .30
MFC historically has paid cash dividends on a quarterly basis. The
final determination of the timing, amount and payment of dividends on the Common
Stock is at the discretion of MFC's Board of Directors and will depend upon the
earnings of MFC and its subsidiaries, principally its subsidiary bank, the
financial condition of MFC and other factors, including general economic
conditions and applicable governmental regulations and policies. MFC or the Bank
has paid regular cash dividends for over 200 consecutive quarters.
As of March 4, 2003, MFC had approximately 1,350 shareholders of
record.
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ITEM 6. SELECTED FINANCIAL DATA
The information set forth in the following table should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto.
Years Ended December 31,
2002 2001 2000 1999 1998
(In thousands, except ratios and per share amounts)
Income Statement Data:
Interest income $23,758 $21,822 $19,209 $15,522 $13,785
Interest expense 6,524 7,814 7,041 5,345 5,313
Net interest income $17,234 $14,008 $12,168 $10,177 $8,472
Provision for loan losses 300 300 400 420 135
Net interest income after
provision for loan losses $16,934 $13,708 $11,768 $9,757 $8,337
Noninterest income 7,312 4,827 3,669 2,959 2,187
Securities gains (losses) (73) 384 (204) (13) (18)
Noninterest expense 15,526 11,947 9,555 8,040 6,674
Income before income taxes $8,647 $6,972 $5,678 $4,663 $3,832
Income taxes 2,335 1,755 1,450 1,097 857
Net income $6,312 $5,217 $4,228 $3,566 $2,975
Per Share Data:
Net Income, Basic $3.47 $2.99 $2.43 $2.00 $1.65
Net Income, Diluted 3.39 2.93 2.41 1.99 1.63
Cash Dividends 1.20 1.00 0.84 0.68 0.75
Book value at period end 22.35 17.31 15.68 12.97 12.85
Balance Sheet Data:
Assets $424,974 $354,101 $289,461 $243,925 $205,403
Loans, net of unearned income 212,107 196,400 177,598 143,235 121,323
Securities 163,673 124,351 81,577 67,739 57,786
Deposits 328,903 271,731 224,640 203,837 172,680
Shareholders' equity 41,410 30,338 27,271 23,075 22,863
Average shares outstanding, 1,821 1,746 1,741 1,779 1,803
Basic
Average shares outstanding, 1,863 1,783 1,752 1,795 1,821
Diluted
Performance Ratios:
Return on Average Assets 1.62% 1.67% 1.62% 1.60% 1.54%
Return on Average Equity 17.24% 17.55% 17.46% 15.48% 13.24%
Capital to Assets 9.74% 8.57% 9.42% 9.49% 11.13%
Dividend payout 35.04% 33.53% 34.57% 34.00% 45.45%
Efficiency (1) 60.93% 60.4% 57.4% 57.9% 58.5%
Capital and Liquidity Ratios:
Risk-based capital ratios:
Tier 1 capital 14.8% 16.4% 12.7% 14.0% 17.1%
Total capital 15.6% 17.3% 13.6% 14.8% 17.9%
Leverage 10.6% 12.5% 9.7% 10.8% 11.2%
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(1) Computed by dividing noninterest expense by the sum of net interest income
on a tax equivalent basis and noninterest income, net of securities
gains or losses.
-10-
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 MFC. This discussion and analysis should be read in
conjunction with the Company's Consolidated Financial Statements and Notes to
Consolidated Financial Statements.
Critical Accounting Policies
The financial condition and results of operations presented in the
Consolidated Financial Statements, accompanying Notes to the Consolidated
Financial Statements and management's discussion and analysis are, to a large
degree, dependent upon the accounting policies of the Company. The selection and
application of these accounting policies involve judgments, estimates, and
uncertainties that are susceptible to change.
Presented below is discussion of those accounting policies that
management believes are the most important ("Critical Accounting Policies") to
the portrayal and understanding of the Company's financial condition and results
of operations. These Critical Accounting Policies require management's most
difficult, subjective and complex judgments about matters that are inherently
uncertain. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of
materially different financial condition or results of operations is a
reasonable likelihood.
Allowance for Loan Losses
The Company monitors and maintains an allowance for loan losses to
absorb an estimate of probable losses inherent in the loan and lease portfolio.
The Company maintains policies and procedures that address the systems of
controls over the following areas of maintenance of the allowance: the
systematic methodology used to determine the appropriate level of the allowance
to provide assurance they are maintained in accordance with accounting
principles generally accepted in the United States of America; the accounting
policies for loan charge-offs and recoveries; the assessment and measurement of
impairment in the loan and lease portfolio; and the loan grading system.
The Company evaluates various loans individually for impairment as
required by Statement of Financial Accounting Standard ("SFAS") No. 114,
Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures.
Loans evaluated individually for impairment include non-performing loans, such
as loans on non-accrual, loans past due by 90 days or more, restructured loans
and other loans selected by management. The evaluations are based upon
discounted expected cash flows or collateral valuations. If the evaluation shows
that a loan is individually impaired, then a specific reserve is established for
the amount of impairment. If a loan evaluated individually is not impaired, then
the loan is assessed for impairment under SFAS No. 5, Accounting for
Contingencies ("SFAS 5"), with a group of loans that have similar
characteristics.
For loans without individual measures of impairment, the Company makes
estimates of losses for groups of loans as required by SFAS 5. Loans are grouped
by similar characteristics, including the type of loan, the assigned loan grade
and the general collateral type. A loss rate reflecting the expected loss
inherent in a group of loans is derived based upon estimates of default rates
for a given loan grade, the predominant collateral type for the group and the
terms of the loan. The resulting estimate of losses for groups of loans are
adjusted for relevant environmental factors and other conditions of the
portfolio of loans and leases, including: borrower and industry concentrations;
levels and trends in delinquencies,
-11-
charge-offs and recoveries; changes in underwriting standards and risk
selection; level of experience, ability and depth of lending management; and
national and local economic conditions.
The amount of estimated impairment for individually evaluated loans and
groups of loans is added together for a total estimate of loans and lease
losses. This estimate of losses is compared to the allowance for loan and lease
losses of the Company as of the evaluation date and, if the estimate of losses
is greater than the allowance, an additional provision to the allowance would be
made. If the estimate of losses is less than the allowance, the degree to which
the allowance exceeds the estimate is evaluated to determine whether the
allowance falls outside a range of estimates. If the estimate of losses is below
the range of reasonable estimates, the allowance would be reduced by way of a
credit to the provision for loan losses. The Company recognizes the inherent
imprecision in estimates of losses due to various uncertainties and variability
related to the factors used, and therefore a reasonable range around the
estimate of losses is derived and used to ascertain whether the allowance is too
high. If different assumptions or conditions were to prevail and it is
determined that the allowance is not adequate to absorb the new estimate of
probable losses, an additional provision for loan losses would be made, which
amount may be material to the Consolidated Financial Statements.
Valuation of Derivatives
The Company maintains an overall interest rate risk management strategy
that incorporates the use of derivative financial instruments. The Company has
used derivative financial instruments only for asset/liability management
through the hedging of a specific transaction or position, and not for trading
or speculative purposes.
Management believes that the risk associated with using derivative
financial instruments to mitigate interest rate risk sensitivity is minimal and
should not have any material unintended impact on the Company's financial
condition or results of operations.
Intangibles and Goodwill
The Company has approximately $6.9 million in intangible assets and
goodwill at December 31, 2002, an increase of $5.9 million since December 31,
2001. The increase is associated with the April 1, 2002 acquisition of Gilkison
Patterson Investment Advisors, Inc. ("GPIA"), a registered investment advisor.
In connection with this investment, a purchase price valuation (using FAS 141
and 142 as a guideline) was completed to determine the appropriate allocation to
identified intangibles. The valuation concluded that approximately 42% of the
purchase price was related to the acquisition of customer relationships with an
amortizable life of 15 years. Another 19% of the purchase price was allocated to
a non-compete agreement with an amortizable life of 7 years. The remainder of
the purchase price has been allocated to goodwill.
The purchase price allocation process requires management estimates and
judgment as to expectations for the life span of various customer relationships
as well as the value that key members of management add to the success of the
Company. For example, customer attrition rates were determined based upon
assumptions that the past five years may predict the future. If the actual
attrition rates, among other assumptions, differed from the estimates and
judgments used in the purchase price allocation, the amounts recorded in the
financial statements could result in a possible impairment of the intangible
assets and goodwill or require an acceleration in the amortization expense.
In addition, FAS 142 requires that goodwill be tested annually using a
two-step process. The first step is to identify a potential impairment. The
second step measures the amount of the impairment loss, if any. Processes and
procedures have been identified for the two-step process.
-12-
When the Company completes its ongoing review of the recoverability of
intangible assets and goodwill, factors that are considered important to
determining whether an impairment might exist include loss of customers acquired
or significant withdrawals of the assets currently under management and/or early
retirement or termination of key members of management. Any changes in the key
management estimates or judgments could result in an impairment charge, and such
a charge could have an adverse effect on the Company's financial condition and
results of operations.
Overview
MFC is headquartered in Middleburg, Virginia and conducts its primary
operations through three wholly owned subsidiaries, the Bank, Tredegar and GPIA.
The Bank is a community bank serving western Loudoun County, Virginia with five
full service branches and one limited service facility. Tredegar is a trust
company headquartered in Richmond, Virginia with a branch office in Middleburg,
Virginia. GPIA is a registered investment advisor headquartered in Alexandria,
Virginia serving clients in 26 states.
MFC exercised its option to buy GPIA in April 2002. The terms of the
transaction include a total purchase price of $6 million with 59,874 common
shares of MFC issued to the shareholders of GPIA. At the time of acquisition
GPIA had approximately $630 million of assets under management with clients in
30 states. Clients who are located in Washington, DC, Maryland and Virginia
account for approximately 68% of the assets under management. With the addition
of GPIA, assets under management by both Tredegar and GPIA exceeded $1 billion
at December 31, 2002.
In 2002, MFC continued to realize the benefit of high growth rates in
both assets and net earnings. Results for 2002 were also favorably affected by
the growth in revenues from the Bank's mortgage banking and investment sales
operations. By December 31, 2002, total assets were $425.0 million, an increase
of 20.0%. Total assets at December 31, 2001 were $354.1 million. Loans, net of
unearned income, grew 8.0% from $196.4 million at December 31, 2001 to $212.1
million at December 31, 2002. Total deposits increased $57.2 million from $271.7
million at December 31, 2001 to $328.9 million at December 31, 2002. MFC remains
well capitalized with risk-adjusted core capital and total capital ratios well
above the regulatory minimums. Asset quality measures also remained consistently
strong throughout the year.
MFC is not aware of any current recommendations by any regulatory
authorities that, if they were implemented, would have a material effect on the
registrant's liquidity, capital resources or results of operations.
-13-
Results of Operations
Net Income
Net income for 2002 was $6.3 million, an increase of 21.0% over 2001's
net income of $5.2 million. Net income for 2001increased 23.4% over 2000's net
income of $4.2 million. For 2002, earnings per diluted share were $3.39 compared
to $2.93 and $2.41 for 2001 and 2000, respectively.
Return on average assets ("ROA") measures how effectively MFC employs
its assets to produce net income. The ROA for MFC decreased slightly to 1.62%
for the year ended December 31, 2002 from 1.67% for the same period in 2001. The
decrease in the net interest margin and additional investments in fixed assets
during 2002 contributed to the five basis point decrease in the ROA. The ROA for
2000 was 1.62%. Return on average equity (ROE), another measure of earnings
performance, indicates the amount of net income earned in relation to the total
equity capital invested. ROE decreased to 17.24% for the year ended December 31,
2002. The additional capital issued in the acquisition of GPIA contributed the
decrease in ROE during 2002. ROE was 17.6% and 17.5% for the years ended
December 31, 2001 and 2000, respectively.
-14-
Average Balances, Income and Expenses, Yields and Rates
Years Ended December 31,
-------------------------------------------------------------------------------------------------
2002 2001 2000
-------------------------------------------------------------------------------------------------
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
-------------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets :
Securities:
Taxable $ 101,725 $ 5,629 5.53% $ 52,040 $ 3,364 6.46% $ 46,838 $ 3,334 7.12%
Tax-exempt (1) (2) 36,471 2,757 7.56% 38,748 2,933 7.57% 30,963 2,392 7.73%
--------- --------- ---------- --------- ---------- ---------
Total securities $ 138,197 $ 8,386 6.07% $ 90,788 $ 6,297 6.94% $ 77,801 $ 5,726
Loans
Taxable $ 213,844 $ 16,137 7.55% $ 194,835 $ 16,297 8.36% $ 160,658 $ 14,049 8.74%
Tax-exempt 758 63 8.32% 520 46 8.85% 437 41 9.38%
--------- --------- ---------- --------- ---------- ---------
Total loans $ 214,602 $ 16,200 7.55% $ 195,355 $ 16,343 8.37% $ 161,095 $ 14,090 8.75%
Federal funds sold 5,396 82 1.52% 3,046 117 3.84% 2,800 170 6.07%
Interest on money market investments 2,194 39 1.77% 1,742 63 3.62% 512 40 7.81%
Interest bearing deposits in
other financial institutions 349 5 1.30% 250 9 3.60% 104 4 3.85%
--------- --------- ---------- --------- ---------- ---------
Total earning assets $ 360,738 $ 24,712 6.85% $ 291,181 $ 22,829 7.84% $ 242,312 $ 20,030 8.27%
Less: allowances for credit losses (2,187) (1,948) (1,595
Total nonearning assets 31,071 23,508 20,875
--------- --------- ----------
Total assets $ 389,621 $ 312,741 $ 261,592
========= ========= ==========
Liabilities:
Interest-bearing deposits:
Checking $ 39,430 $ 93 0.24% $ 33,978 $ 223 0.66% $ 32,461 $ 295 0.91%
Regular savings 19,813 183 0.92% 15,183 278 1.83% 13,148 263 2.00%
Money market savings 66,102 905 1.37% 46,616 1,166 2.50% 42,852 1,162 2.71%
Time deposits:
$100,000 and over 51,723 1,648 3.19% 39,154 2,086 5.33% 25,997 1,453 5.59%
Under $100,000 44,367 1,392 3.14% 46,409 2,088 4.50% 44,389 2,151 4.85%
--------- --------- ---------- --------- ---------- ---------
Total interest-bearing deposits $ 221,435 $ 4,221 1.91% $ 181,340 $ 5,841 3.22% $ 158,847 $ 5,324 3.35%
Federal Home Loan Bank Advances 3,126 115 3.68% 7,543 482 6.39% 9,186 584 6.36%
Securities sold under agreements
to repurchase 13,434 177 1.31% 13,292 399 3.00% 12,279 616 5.02%
Long-term debt 38,156 2,007 5.26% 19,332 1,076 5.57% 8,090 500 6.18%
Federal Funds Purchased 221 4 1.78% 371 16 4.31% 286 17 5.94%
--------- --------- ---------- --------- ---------- ---------
Total interest-bearing liabilities $ 276,373 $ 6,524 2.36% $ 221,878 $ 7,814 3.52% $ 188,688 $ 7,041 3.73%
Non-interest bearing liabilities
Demand Deposits 74,787 59,289 47,355
Other liabilities 1,860 1,854 1,329
--------- --------- ----------
Total liabilities $ 353,019 $ 283,021 $ 237,372
Shareholders' equity
36,602 29,720 24,220
--------- --------- ----------
Total liabilities and shareholders'
Equity $ 389,621 $ 312,741 $ 261,59
========= ========= ==========
--------- --------- ---------
Net interest income $ 18,188 $ 15,015 $ 12,989
========= ========= =========
Interest rate spread 4.49% 4.32% 4.54%
Interest expense as a percent of
average earning assets 1.81% 2.68% 2.91%
Net interest margin 5.04% 5.16% 5.36%
- ----------
(1) Income and yields are reported on tax equivalent basis assuming a
federal tax rate of 34%.
(2) Income and yields include dividends on preferred bonds that are 70%
excludable for tax purposes.
-15-
Net Interest Income
Net interest income represents the principal source of earnings of MFC.
Net interest income is the amount by which interest generated from earning
assets exceeds the expense of funding those assets. Changes in volume and mix of
interest earning assets and interest bearing liabilities, as well as their
respective yields and rates, have a significant impact on the level of net
interest income.
Net interest income on a fully tax-equivalent basis was $18.2 million
for the year ended December 31, 2002. This is an increase of 21.1% over the
$15.0 million reported for the same period in 2001. Net interest income for 2001
increased 15.6% over the $13.0 million reported for 2000.
The increase in net interest income in 2002 resulted from the 23.9%
growth in average earning assets. The 99 basis point decrease in earning assets
yield was offset by a 116 basis point decrease in the cost of funding, which
allowed the net interest margin to remain above 5% throughout 2002. The average
balance in the securities portfolio increased by $47.4 million while the
tax-equivalent yield decreased 87 basis points to 6.07%. Nevertheless, the
increase in the average balance of the securities portfolio was able to provide
$2.1 million in additional interest income on a tax-equivalent basis. The
average loan portfolio volume increased 9.9% during 2002. Conversely, the
average yield on the loan portfolio decreased 82 basis points. Loan demand was
strong throughout 2002; however, the loan portfolio experienced significant run
off due to borrower refinancings of residential real estate loans.
In 2002, MFC experienced significant growth in its interest bearing
checking, savings and money market accounts. Despite a 30.9% increase in the
average balances of these accounts, the decline in deposit rates during 2002
allowed MFC to experience a decrease in the respective interest expenses of
$486,000. The average balances in certificates of deposit increased 12.3%, while
the interest expense associated with these deposits decreased 27.2% or $1.1
million.
MFC's reliance on other funding sources, such as the Federal Home Loan
Bank overnight advances, decreased on average by $4.4 million with a related
decrease in interest expense of $367,000. During 2002, however, MFC increased on
average its long term borrowings from the Federal Home Loan Bank by $10.8
million. Total interest expense for 2002 was $6.5 million, a decrease of $1.3
million compared to the total interest expense for 2001.
The increase in net interest income in 2001 resulted from largely from
the continued growth in the average earning assets. Both the assets yields and
the cost of funding decreased at ratable amounts resulting in a decrease of 20
basis points in the net interest margin. The average balance in the securities
portfolio increased $13.0 million, while the tax-equivalent yield decreased 42
basis points to 6.94%, providing $571,000 in additional interest income on a
tax-equivalent basis. The asset/liability strategies employed by management
influenced the increase in the investment portfolio yield. The average loan
portfolio volume increased 21.3% during 2001, providing $2.8 million in interest
income, while the average yield on the loan portfolio decreased 38 basis points,
causing the interest income provided by the loan portfolio to decrease by
$579,000.
In 2001, MFC experienced respectable growth in its interest bearing
checking, savings and money market accounts. In spite of the 8.3% increase in
the average balances, the decline in deposit rates during 2001 allowed MFC to
experience a decrease in the respective interest expenses of $53,000. The
average balances in certificates of deposit increased 21.6%, while the interest
expense associated with these deposits increased 15.8% or $570,000. The decline
in the average rate paid on certificates of deposit produced a decrease in
interest expense of approximately $235,000, while the increased volume of
certificates of deposit increased interest expense by approximately $805,000.
-16-
MFC's reliance on other funding sources, such as the Federal Home Loan
Bank overnight advances, decreased on average by $1.6 million with a related
decrease in interest expense of $102,000. However, during 2001, MFC increased on
average its long term borrowings from the Federal Home Loan Bank by $9.5
million. During the fourth quarter of 2001, MFC issued $10 million in trust
preferred securities adding $1.7 million in average long term debt to the
balance sheet. The interest expense related to the trust preferred securities is
also included in long term debt interest expense and amounted to approximately
$59,000. Total interest expense for 2001 was $7.8 million, an increase of
$773,000 compared to 2000.
-17-
The following table analyzes changes in net interest income
attributable to changes in the volume of interest-bearing assets and liabilities
compared to changes in interest rates. The change in interest due to both volume
and rate has been allocated to volume and rate changes in proportion to the
relationship of the absolute dollar amounts of the change in each. Nonaccruing
loans are included in the average outstanding loans.
Volume and Rate Analysis
(Tax Equivalent Basis)
Years Ended December 31,
---------------------------------------------------------------
2002 vs 2001 2001 vs 2000
Increase (Decrease) Due Increase (Decrease) Due
to Changes in: to Changes in:
---------------------------------------------------------------
(In Thousands)
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
Earning Assets:
Securities:
Taxable $ 2,667 $ (402) $ 2,265 $ 181 $ (151) $ 30
Tax-exempt (172) (4) (176) 590 (49) 541
Loans:
Taxable 1,495 (1,655) (160) 2,825 (577) 2,248
Tax-exempt 20 (3) 17 7 (2) 5
Federal funds sold 126 (161) (35) 17 (70) (53)
Interest on money market investments 25 (49) (24) 30 (7) 23
Interest bearing deposits in other
financial institutions 7 (11) (4) 5 -- 5
------- ------- ------- ------- ------- -------
Total earning assets $ 4,168 $(2,285) $ 1,883 $ 3,655 $ (856) $ 2,799
------- ------- ------- ------- ------- -------
Interest-Bearing Liabilities:
Interest checking $ 44 $ (174) (130) $ 15 $ (87) (72)
Regular savings deposits 151 (246) (95) 33 (18) 15
Money market deposits 381 (642) (261) 34 (30) 4
Time deposits
$100,000 and over 550 (988 (438) 697 (64) 633
Under $100,000 (88) (608) (696) 108 (171) (63)
------- ------- ------- ------- ------- -------
Total interest bearing deposits $ 1,038 $(2,658) $(1,620) $ 887 $ (370) $ 517
------- ------- ------- ------- ------- -------
Federal Home Loan Bank
Advances $ (213) $ (154) $ (367) $ (105) $ 3 $ (102)
Securities sold under agree-
ment to repurchase 4 (226) (222) 56 (273) (217)
Long-term debt 987 (56) 931 620 (44) 576
Federal Funds Purchased (5) (7) (12) (13) 12 (1)
------- ------- ------- ------- ------- -------
Total interest bearing
liabilities $ 1,811 $(3,101) $(1,290) $ 1,445 $ (672) $ 773
------- ------- ------- ------- ------- -------
Change in net interest income $ 2,357 $ 816 $ 3,173 $ 2,210 $ (184) $ 2,026
======= ======= ======= ======= ======= =======
- ---------
(1) The change in interest, due to both rate and volume, has been allocated to
change due to volume and change due to rate in proportion to the
relationship of the absolute dollar amounts of the change in each.
-18-
Provision for Loan Losses
MFC's loan loss provision during 2002 and 2001 was $300,000. MFC is
committed to making loan loss provisions that maintain an allowance that
adequately reflects the risk inherent in the loan portfolio. This commitment is
more fully discussed in the "Asset Quality" section below.
Noninterest Income
Noninterest income has been and will continue to be an important factor
for increasing profitability. Management recognizes this and continues to review
and consider areas where non-interest income can be increased. Noninterest
income includes fees generated by the mortgage banking and investment sales
departments of the Bank as well as by Tredegar and GPIA. Trust fee income
decreased 7.7% during 2002 to $1.2 million. A significant portion of trust fees
are based upon a percentage of the market value of the assets under management,
so any decreases in market value of the assets under management result in a
similar decrease in fees. Tredegar's accounts are typically invested in equities
with a smaller allocation to fixed income securities. The continued decline in
equity market values have more than offset all of the growth in the fees as
result of new business. GPIA's investment advisory fees added $1.5 million to
noninterest income for the eight months that they have been a subsidiary of MFC.
Like Tredegar, their fees are based upon a percentage of the market value of the
assets under management; however, GPIA's clients have substantially more
invested in fixed income securities. The fixed income market typically has an
opposite reaction to the equity markets. Thus, about 5% of their fee increase
over 2001 is related to relative increases in market values of the portfolios
managed while the remaining 3% is related to new business growth. Due to
historic low mortgage rates and increased refinancings, the mortgage banking
department contributed an additional $452,000 of fees on loans held for sale
during 2002. During 2002, the Bank increased its transaction oriented deposit
accounts by 30.5% resulting in growth in service charges and fee income. The
service charges and fees associated with deposit accounts increased 35.0% during
2002. During 2002, MFC realized $73,000 in net losses as a result of
restructuring the investment portfolio in response to the change in the interest
rate environment in 2002. Total noninterest income for 2002 was $7.2 million,
compared to $5.2 million for 2001.
-19-
Noninterest income for 2001 increased 50.4% to $5.2 million from $3.5
million in 2000. The increase is due primarily to the increase on fees on loans
held for sale, investment sales fees and service charges on deposit accounts.
The mortgage banking department contributed an additional $840,000 of fees on
loans held for sale during 2001. The service charges and fees associated with
deposit accounts increased 23.1% during 2001. The increase in these fees was due
primarily to a 31.2% increase in transaction oriented deposit account growth.
Noninterest Income
Year Ended December 31,
----------------------------
2002 2001 2000
------- ------- -------
(In thousands)
Service charges, commissions and fees $ 1,960 $ 1,452 $ 1,180
Trust fee income 1,181 1,279 1,594
Investment advisory fee income 1,544 -- --
Fees on loans held for sale 1,935 1,483 643
Commission on investment sales 611 485 116
Other operating income 81 128 136
------- ------- -------
Noninterest income $ 7,312 $ 4,827 $ 3,669
Gains (losses) on securities available for
sale, net (73) 384 (204)
------- ------- -------
Total noninterest income $ 7,239 $ 5,211 $ 3,465
======= ======= =======
Noninterest Expenses
Improving operating efficiency is as important to management as
enhancing noninterest income. Total noninterest expenses increased 30.0% or $3.6
million to $15.5 million in 2002. The acquisition of GPIA on April 1, 2002
accounts for 32.3% or $1.1 million of the total increase in noninterest
expenses. Salaries and employee benefits increased $2.2 million or 30.7% due to
increased commission expense for fee-related business and enhancing the internal
infrastructure to support a growing organization. Approximately $673,000 of the
$2.2 million increase in salaries expense is related to the acquisition of GPIA.
Occupancy and equipment expense increased $605,000 or 48.6% to $1.9 million. The
costs to move the existing operations departments from the Company's main office
to the operations facility as well as readying the buildings for occupancy have
caused the increase in occupancy and equipment expense. Advertising expense
increased 29.4% in 2002. Two additional bank mergers within the market areas
presented opportunities for additional image advertising that resulted in
increased business. Computer operations expense increased 32.1% to $539,000
during 2002. The Company placed in service additional equipment to enhance the
security infrastructure of the internal network as well as upgraded the core
bank processing software. An increase in the usage of internet banking services
by accountholders also contributed to the increase in computer operations
expense. Other operating expenses increased $546,000 to $3.3 million for 2002
compared to $2.8 million for 2001. Expenses associated with servicing an
increased volume of accounts and transactions such as postage and printing have
also impacted other operating expenses in 2002.
-20-
Noninterest expenses increased 25.0% or $2.4 million to $11.9 million
in 2001. This increase resulted from both pressures to provide competitive
salary and benefit programs and occupancy and equipment investments to position
the Bank for future growth and productivity.
Noninterest Expenses
Years Ended December 31,
--------------------------------------
2002 2001 2000
-------- --------- ---------
(In thousands)
Salaries and employee benefits $ 9,383 $ 7,180 $ 5,600
Net occupancy and equipment expense 1,851 1,246 1,172
Advertising 414 320 347
Computer operations 539 408 298
Other operating expenses 3,339 2,793 2,138
-------- --------- ---------
Total $ 15,526 $ 11,947 $ 9,555
======== ========= =========
Income Taxes
Reported income tax expense was $2.3 million for 2002, an increase of
$580,000 compared to $1.8 million for 2001. The effective tax rate for 2002 was
27.0% compared to 25.2% in 2001 and 25.5% in 2000. The increase in the effective
tax rate for 2002 was influenced by the change in the mix of the investment
securities portfolio as well as the increase in non-interest income. Note 10 of
the Company's Consolidated Financial Statements provides a reconciliation
between the amount of income tax expense computed using the federal statutory
rate and MFC's actual income tax expense. Also included in Note 10 to the
Consolidated Financial Statements is information regarding the principal items
giving rise to deferred taxes for the two years ended December 31, 2002.
-21-
Summary of Financial Results by Quarter
2002 Quarter Ended
----------------------------------------------------------
(Dollars in thousands except per share) March 31 June 30 September 30 December 31
------------- ------------ ---------------- --------------
Net interest income $ 4,156 $ 4,290 $ 4,391 $ 4,397
Net interst income after provision
for loan losses 4,081 4,215 4,316 4,322
Non interest income 1,184 1,815 2,061 2,253
Net securities gains (losses) (80) 33 (31) 5
Non interest expense 3,128 3,711 4,058 4,630
Income before income taxes 2,057 2,352 2,288 1,950
Net income 1,514 1,686 1,642 1,470
Earnings per common share - assuming dilution $ 0.84 $ 0.90 $ 0.87 $ 0.78
Dividends per common share 0.30 0.30 0.30 0.30
2001 Quarter Ended
----------------------------------------------------------
(Dollars in thousands except per share) March 31 June 30 September 30 December 31
------------- ------------ ---------------- --------------
Net interest income $ 3,120 $ 3,422 $ 3,555 $ 3,911
Net interst income after provision
for loan losses 3,045 3,347 3,480 3,836
Non interest income 1,168 1,096 1,254 1,309
Net securities gains (losses) 252 (6) 66 72
Non interest expense 2,741 2,829 2,930 3,447
Income before income taxes 1,724 1,608 1,870 1,770
Net income 1,292 1,199 1,389 1,337
Earnings per common share - assuming dilution $ 0.73 $ 0.67 $ 0.77 $ 0.75
Dividends per common share 0.25 0.25 0.25 0.25
Financial Condition
MFC's total assets were $424.9 million as of December 31, 2002, up
$70.9 million or 20.0% from the $354.1 million level at December 31, 2001.
Securities increased $39.3 million or 31.6% from 2001 to 2002. Loans increased
by $15.7 million or 8.0% from 2001 to 2002, while deposits increased $57.2
million or 21.0% during the same period. Borrowings from the Federal Home Loan
Bank increased $4.0 million during 2002. It is anticipated that the borrowings
from the Federal Home Loan Bank will continue to rise should deposit growth not
match asset growth. Total shareholders' equity at year end 2002 and 2001 was
$41.4 million and $30.3 million, respectively.
Loans
MFC's loan portfolio is its largest and most profitable component of
earning assets, totaling 59.5% of average earning assets in 2002. MFC continues
to emphasize loan portfolio growth and diversification as a means of increasing
earnings while minimizing credit risk. Loans, net of unearned
-22-
income, were $212.1 million at December 31, 2002, an increase of 8.0% from
December 31, 2001's total of $196.4 million. Proactive sales efforts,
competitive pricing and the branch network supported the increase in loans
during 2002. Loans increased 10.6% from $177.6 million at December 31, 2000 to
$196.4 million at December 31, 2001. The loan to deposit ratio decreased to
64.5% at December 31, 2002 compared to 72.3% at December 31, 2001 and 79.1% at
December 31, 2000.
Loan Portfolio
December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
(In thousands)
Commercial, financial and agricultural $ 20,323 $ 22,993 $ 22,555 $ 19,055 $ 18,880
Real estate construction 22,008 24,174 17,693 12,151 5,436
Real estate mortgage:
Residential (1-4 family) 74,298 80,824 81,545 61,062 55,595
Home equity lines 10,091 8,271 5,973 4,382 3,617
Non-farm, non-residential (1) 73,164 48,074 38,812 36,361 28,643
Agricultural 482 163 346 379 1,057
Consumer installment 11,741 11,901 10,674 9,845 8,095
-------- -------- -------- -------- ---------
Total loans $212,107 $196,400 $177,598 $143,235 $121,323
======== ======== ======== ======== ========
- ---------
(1) This category generally consists of commercial and industrial loans where
real estate constitutes a source of collateral.
At December 31, 2002, residential real estate (1-4 family) portfolio
loans constituted 35.0% of the total portfolio and decreased $6.5 million during
the year. The current historic low mortgage interest rates have caused many of
the Bank's clients to refinance to a long term fixed rate product. Real estate
construction loans consist primarily of pre-sold 1-4 family residential loans
along with a marginal amount of commercial construction loans. Real estate
construction loans increased to $22.0 million at December 31, 2002 and represent
10.4% of the total loan portfolio. MFC's one time closing construction/permanent
loan product competes successfully in a high growth market like Loudoun County
because MFC is local and can respond quickly to inspections and construction
draw requests. Non-farm, non-residential real estate loans are typically
owner-occupied commercial buildings. Non-farm, non-residential loans were 34.5%
of the total loan portfolio at December 31, 2002. The increase in the non-farm
non-residential real estate loans is the result of an increased focus on
diversifying the loan portfolio. The Bank has hired commercial business
development officers who have been successful in attracting new business to the
Bank. The branch network has also helped to support the loan portfolio
diversification, such as increased commercial real estate loans. Home equity
lines and agricultural real estate loans were 4.8% and 0.23% of total loans,
respectively, at December 31, 2002.
MFC's commercial, financial and agricultural loan portfolio consists of
secured and unsecured loans to small businesses. At December 31, 2002, these
loans comprised 9.6% of the loan portfolio. This portfolio decreased 11.6% in
2002 to $20.3 million. Generally business debt has declined nationwide as well
as locally thus causing a decrease in loan demand. Consumer installment loans
primarily consist of unsecured installment credit and account for 5.5% of the
loan portfolio.
Consistent with its focus on providing community-based financial
services, MFC generally does not extend loans outside its principal market area.
MFC's market area for its lending services encompasses Fauquier and Loudoun
Counties, where it operates full service branches.
-23-
MFC's unfunded loan commitments totaled $31.6 million at December 31,
2002 and $34.2 million at December 31, 2001. The decrease in the amount of
unfunded commitments is attributed in part to the increase in real estate
construction financing as well as customer demand for credit line products,
primarily home equity lines.
At December 31, 2002, MFC had no concentration of loans in any one
industry in excess of 10% of its total loan portfolio. However, because of the
nature of MFC's market, loan collateral is predominantly real estate.
The following table reflects the maturity distribution of selected loan
categories:
Remaining Maturities of Selected Loan Categories
December 31, 2002
Commercial, Real
Financial and Estate
Agricultural Construction
--------------- --------------
(Dollars in thousands)
Within 1 year $ 16,340 $ 10,762
--------------- --------------
Variable Rate:
1 to 5 years $ 1,600 $ 896
After 5 years - 631
--------------- --------------
Total $ 1,600 $ 1,527
--------------- --------------
Fixed Rate:
1 to 5 years $ 2,383 $ 8,790
After 5 years - 929
--------------- --------------
Total $ 2,383 $ 9,719
--------------- --------------
Total Maturities $ 20,323 $ 22,008
=============== ==============
Asset Quality
MFC has policies and procedures designed to control credit risk and to
maintain the quality of its loan portfolio. These include underwriting standards
for new originations and ongoing monitoring and reporting of asset quality and
adequacy of the allowance for loan losses. Total nonperforming assets, which
consist of nonaccrual loans, restructured loans and foreclosed property, were
$1.1 million at December 31, 2002. This is an increase of $984,000 from the
December 31, 2001 balance of $79,000. The increase is largely two residential
real estate loans both of which are well secured. Nonperforming assets at
December 31, 2001 decreased $26,000 from $105,000 at December 31, 2000.
Nonperforming Assets
Loans are placed on nonaccrual status when collection of principal and
interest is doubtful, generally when a loan becomes 90 days past due. There are
three negative implications for earnings when a loan is placed on nonaccrual
status. First, all interest accrued but unpaid at the date that the loan is
placed on nonaccrual status is either deducted from interest income or written
off as a loss. Second, accruals of interest are discontinued until it becomes
certain that both principal and interest can be repaid.
-24-
Finally, there may be actual losses that require additional provisions for loan
losses be charged against earnings. For real estate loans, upon foreclosure, the
balance of the loan is transferred to "Other Real Estate Owned" ("OREO") and
carried at the lower of the outstanding loan balance or the fair market value of
the property based on current appraisals and other current market trends. If a
write down of the OREO property is necessary at the time of foreclosure, the
amount is charged-off against the allowance for loan losses. A review of the
recorded property value is performed in conjunction with normal loan reviews,
and if market conditions indicate that the recorded value exceeds the fair
market value, additional write downs of the property value are charged directly
to operations.
Nonperforming Assets
December 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- -------------- ------------ ------------- -------------
(In thousands)
Nonaccrual loans $ 1,063 $ 79 $ 105 $ 530 $ 409
Restructured loans - - - - -
Foreclosed property - - - - 200
-------- -------- -------- -------- --------
Total nonperforming assets $ 1,063 $ 79 $ 105 $ 530 $ 609
======== ======== ======== ======== ========
Allowance for loan losses
to nonperforming assets 217% 2608% 1718% 274% 175%
Nonperforming assets to
period end loans 0.50% 0.04% 0.06% 0.37% 0.50%
During 2002 and 2001, approximately $41,000 and $700, respectively, in
additional interest income would have been recorded if MFC's nonaccrual loans
had been current and in accordance with their original terms.
At December 31, 2002, the Company had no potential problem loans.
The allowance for loan losses was 217% of nonperforming loans at
December 31, 2002. At December 31, 2001 and 2000 the allowance for loan losses
was 2,608% and 1,718% of nonperforming loans. Management evaluates nonperforming
loans relative to their collateral value and makes appropriate reductions in the
carrying value of those loans based on that review.
Allowance For Loan Losses
The Company monitors and maintains an allowance for loan losses to
absorb an estimate of probable losses inherent in the loan and lease portfolio.
The Company maintains policies and procedures that address the systems of
controls over the following areas of maintenance of the allowance: the
systematic methodology used to determine the appropriate level of the allowance
to provide assurance they are maintained in accordance with accounting
principles generally accepted in the United States of America; the accounting
policies for loan charge-offs and recoveries; the assessment and measurement of
impairment in the loan and lease portfolio; and the loan grading system.
-25-
The Company evaluates various loans individually for impairment as
required by SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and
SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures. Loans evaluated individually for impairment include
non-performing loans, such as loans on non-accrual, loans past due by 90 days or
more, restructured loans and other loans selected by management. The evaluations
are based upon discounted expected cash flows or collateral valuations. If the
evaluation shows that a loan is individually impaired, then a specific reserve
is established for the amount of impairment. If a loan evaluated individually is
not impaired, then the loan is assessed for impairment under SFAS 5 with a group
of loans that have similar characteristics.
For loans without individual measures of impairment, the Company makes
estimates of losses for groups of loans as required by SFAS 5. Loans are grouped
by similar characteristics, including the type of loan, the assigned loan grade
and the general collateral type. A loss rate reflecting the expected loss
inherent in a group of loans is derived based upon estimates of default rates
for a given loan grade, the predominant collateral type for the group and the
terms of the loan. The resulting estimate of losses for groups of loans are
adjusted for relevant environmental factors and other conditions of the
portfolio of loans and leases, including: borrower and industry concentrations;
levels and trends in delinquencies, charge-offs and recoveries; changes in
underwriting standards and risk selection; level of experience, ability and
depth of lending management; and national and local economic conditions.
The amount of estimated impairment for individually evaluated loans and
groups of loans is added together for a total estimate of loans and lease
losses. This estimate of losses is compared to the allowance for loan and lease
losses of the Company as of the evaluation date and, if the estimate of losses
is greater than the allowance, an additional provision to the allowance would be
made. If the estimate of losses is less than the allowance, the degree to which
the allowance exceeds the estimate is evaluated to determine whether the
allowance falls outside a range of estimates. If the estimate of losses is below
the range of reasonable estimates, the allowance would be reduced by way of a
credit to the provision for loan losses. The Company recognizes the inherent
imprecision in estimates of losses due to various uncertainties and variability
related to the factors used, and therefore a reasonable range around the
estimate of losses is derived and used to ascertain whether the allowance is too
high. If different assumptions or conditions were to prevail and it is
determined that the allowance is not adequate to absorb the new estimate of
probable losses, an additional provision for loan losses would be made, which
amount may be material to the Consolidated Financial Statements.
-26-
The following table depicts the transactions, in summary form, that
occurred to the allowance for loan losses in each year presented:
Allowance for Loan Losses
December 31,
--------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(In thousands)
Balance, beginning of period $2,060 $1,804 $1,453 $1,064 $ 974
Loans charged off:
Commercial, financial, and
agricultural - - 61 26 8
Real estate construction - - - - -
Real estate mortgage - 48 - 29 -
Consumer installment 74 35 35 96 77
------ ------ ------ ------ ------
Total loans charged off $ 74 $ 83 $ 96 $ 151 $ 85
------ ------ ------ ------ ------
Recoveries:
Commercial, financial, and
agricultural $ 2 $- $ 6 $ 7 $ 1
Real estate construction - - - - -
Real estate mortgage - - - 79 6
Consumer installment 19 39 41 34 33
------ ------ ------ ------ ------
Total recoveries $ 21 $ 39 $ 47 $ 120 $ 40
------ ------ ------ ------ ------
Net charge offs (recoveries) 53 44 49 31 45
Provision for loan losses 300 300 400 420 135
------ ------ ------ ------ ------
Balance, end of period $2,307 $2,060 $1,804 $1,453 $1,064
====== ====== ====== ====== ======
Ratio of allowance for loan
losses to loans outstanding
at end of period 1.09% 1.05% 1.02% 1.01% 0.88%
Ratio of net charge offs to
average loans outstanding
during period 0.03% 0.02% 0.03% 0.02% 0.04%
The allowance for loan losses was $2.3 million at December 31, 2002, an
increase of $247,000 from $2.1 million at December 31, 2001. The allowance was
$1.8 million at December 31, 2000. In 2002, MFC's net charge-offs increased
$9,000 from the previous year's net charge-offs of $44,000. Net charge-offs as a
percentage of average loans were 0.03% and 0.02% for 2002 and 2001 respectively.
The provision for loan losses was $300,000 for 2002 and 2001.
-27-
The following table shows the balance and percentage of the MFC's
allowance for loan losses allocated to each major category of loan:
Allocation of Allowance for Loan Losses
Commercial, Financial, Real Estate Real Estate
Agricultural Construction Mortgage Consumer
--------------------------- ----------------------- ------------------------ -----------------------
Allowance Percent of Allowance Percent of Allowance Percent of Allowance Percent of
for Loan in for Loan in for Loan in for Loan in
Loan Category to Loan Category to Loan Category to Loan Category to
Losses Total Loans Losses Total Loans Losses Total Loans Losses Total Loans
--------------------------- ----------------------- ------------------------ -----------------------
(In thousands)
December 31,
2002 $ 487 9.58% $ 624 10.38% $ 924 74.51% $ 272 5.54%
2001 $ 634 11.71% $ 750 12.31% $ 374 69.92% $ 302 6.06%
2000 $ 645 12.70% $ 500 9.96% $ 310 71.33% $ 349 6.01%
1999 $ 580 13.30% $ 350 8.48% $ 178 71.34% $ 345 6.82%
1998 $ 442 15.56% $ 100 4.48% $ 144 73.28% $ 378 6.43%
MFC has allocated the allowance according to the amount deemed
reasonably necessary to provide for the possibility of losses being incurred
within each of the above categories of loans. The allocation of the allowance as
shown in the table above should not be interpreted as an indication that loan
losses in future years will occur in the same proportions that they may have in
prior years or that the allocation indicates future loan loss trends.
Additionally, the proportion allocated to each loan category is not the total
amount that may be available for the future losses that could occur within such
categories since the total allowance is a general allowance applicable to the
total portfolio.
Securities
MFC manages its investment securities portfolio consistent with
established policies that include guidelines for earnings, rate sensitivity,
liquidity and pledging needs. MFC holds bonds issued from the Commonwealth of
Virginia and its political subdivisions with an aggregate book value and market
value of $2.7 million at December 31, 2002. The aggregate holdings of these
bonds approximate 6.6% of MFC's shareholders' equity.
MFC accounts for securities under Financial Accounting Standards Board
("FASB") Statement No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." This standard requires classification of investments into
three categories, "held to maturity" ("HTM"), "available for sale" ("AFS"), or
"trading," as further defined in Note 1 to the Company's Consolidated Financial
Statements. MFC's does not maintain a trading account and has classified no
securities in this category. HTM securities are required to be carried on the
financial statements at amortized cost. AFS securities are carried on the
financial statements at fair value. The unrealized gains or losses, net of
deferred income taxes, are reflected in shareholders' equity. The HTM
classification places restrictions on MFC's ability to sell securities or to
transfer securities into the AFS classification. Since MFC desires the
flexibility to respond to changing balance sheet needs through investment
portfolio management, it has chosen to classify only a small portion of its
portfolio in this category. At December 31, 2002, 2.8% of the portfolio was
classified as HTM.
-28-
MFC holds in its loan and securities portfolios investments that adjust
or float according to changes in "prime" lending rate. These holdings are not
considered speculative but instead necessary for good asset/liability
management.
The carrying value of the securities portfolio was $163.7 million at
December 31, 2002, an increase of $39.3 million or 31.6% from the carrying value
of $124.4 million at December 31, 2001. The market value of the AFS securities
at December 31, 2002 was $159.0 million. The unrealized loss on the AFS
securities was $409,000 that was more than offset by an unrealized gain of $5.4
million at December 31, 2002. The net market value gain at December 31, 2002 is
reflective of the recent decrease in market interest rates. The net unrealized
loss on the AFS securities was $376,000 at December 31, 2001.
Investment Securities Portfolio
The carrying value of securities held to maturity at the dates
indicated were as follows:
December 31,
------------------------------------------------------------
2002 2001 2000
------------------ --------------- --------------
(In thousands)
U.S. Government securities $ - $ - $ 250
State and political subdivision obligations 4,590 5,484 6,657
Mortgage-backed securities 53 61 93
------------------ --------------- --------------
$ 4,643 $ 5,545 $ 7,000
================== =============== ==============
The carrying value of securities available for sale at the dates
indicated were as follows:
December 31,
------------------------------------------------------------
2002 2001 2000
------------------ --------------- --------------
(In thousands)
U.S. Government securities $ 4,406 $ 267 $ 3,072
State and political subdivision obligations 32,639 33,220 27,961
Mortgage-backed securities 102,521 63,746 3,443
Other securities 19,464 21,573 9,501
------------------ --------------- --------------
$ 159,030 $ 118,806 $ 43,977
================== =============== ==============
-29-
The following table indicates the increased return experienced by MFC
by lengthening the maturity of the investment securities portfolio. Securities
with maturities greater than five years total $83.7 million and have an average
yield greater than 6.0%. The securities portfolio represents approximately 38.3%
of the earning assets of MFC. For that reason, it is managed primarily to
provide superior returns without sacrificing interest rate, market and credit
risk. Secondarily through the asset/liability process, MFC considers the
securities portfolio as a liquidity source in the event that funding is needed
quickly within a 30-day period of time.
Maturity Distribution and Yields of Investment Securities
December 31, 2002
Taxable-Equivalent Basis
Due in 1 year Due after 1 year Due after 5 years Due after 10 years
or less through 5 years through 10 years And Equities Total
------------------ ------------------ ----------------- ------------------ -----------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------------------ ------------------ ----------------- ------------------ -----------------
(In housands)
Securities held for investment:
Mortgage backed securities $ 2 4.63% $ 7 4.38% $ 12 4.42% $ 32 4.53% $ 53 4.48%
Tax-exempt securities (1) 376 7.39% 2,630 7.72% 1,584 7.85% - - 4,590 7.74%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total $ 378 7.37% $ 2,637 7.71% $ 1,596 7.83% $ 32 4.53% $ 4,643 7.70%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Securities available for sale:
U.S. Government securities $ 514 2.52% $ 3,615 3.03% $ 277 7.54% $ - - $ 4,406 3.25%
Mortgage backed securities 20,662 5.77% 40,676 5.54% 22,683 5.33% 18,500 5.39% 102,521 5.51%
Other 691 7.20% 6,511 4.76% 204 7.22% 7,980 3.77% 15,386 4.39%
Corporate preferred - - - - - - 2,283 7.23% 2,283 7.23%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total taxable $ 21,867 5.74% $ 50,802 5.26% $ 23,164 5.37% $ 28,763 5.09% $124,596 5.33%
Tax-exempt securities (1) 391 7.92% 1,602 7.98% 11,981 7.56% 18,136 7.71% 32,110 7.67%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total $ 22,258 5.78% $ 52,404 5.35% $ 35,145 6.12% $ 46,899 6.10% $156,706 5.81%
-------- ---- -------- ---- -------- ---- -------- ---- -------- ----
Total securities $ 22,636 5.81% $ 55,041 5.46% $ 36,741 6.19% $ 46,931 6.10% $161,349 5.86%
======== ==== ======== ==== ======== ==== ======== ==== ======== ====
- ---------
(1) Yields on tax-exempt securities have been computed on a tax-equivalent
basis.
(2) Amounts exclude Federal Reserve Stock of $374,400 and Federal Home Loan
Bank Stock of $1,950,000.
Other Earning Assets
MFC's average investments in federal funds sold and money market
investments in 2002 were $5.4 million and $2.2 million, increases of $2.4
million and $452,000, respectively, over the 2001 amounts. Average investments
in federal funds sold and money market investments in 2001 were $3.0 million and
$1.7 million, respectively. Fluctuations in federal funds sold and money market
investments reflect excess deposit growth over loan growth as well as
management's goal to maximize asset yields while maintaining proper
asset/liability structure.
-30-
Deposits
Deposits continue to be an important funding source and primary supply
of MFC's growth. MFC's strategy has been to increase its core deposits at the
same time that it is controlling its cost of funds. The maturation of the branch
network, as well as increased advertising campaigns and bank mergers, have
contributed to the significant growth in deposits over the last several years.
By monitoring interest rates within the local market and that of alternative
funding sources, MFC is able to price the deposits effectively to develop a core
base of deposits in each branch.
The following table is a summary of average deposits and average rates
paid on those deposits:
Average Deposits and Rates Paid
December 31,
-----------------------------------------------------------------------------------
2002 2001 2000
--------------------------- --------------------------- --------------------------
Amount Rate Amount Rate Amount Rate
--------------------------- --------------------------- --------------------------
(Dollars in Thousands)
Noninterest-bearing deposits $ 74,787 - $ 59,289 - $ 47,355 -
Interest-bearing accounts:
Interest checking 39,430 0.24% 33,978 0.66% 32,461 0.91%
Regular savings 19,813 0.92% 15,183 1.83% 13,148 2.00%
Money market accounts 66,102 1.37% 46,616 2.50% 42,852 2.71%
Time deposits:
$ 100,000 and over 51,723 3.19% 39,154 5.33% 25,997 5.59%
Under $ 100,000 44,367 3.14% 46,409 4.50% 44,389 4.85%
----------- ----------- -----------
Total interest-bearing deposits $ 221,435 1.91% $ 181,340 3.22% $ 158,847 3.35%
---------- ----------- -----------
Total $ 296,222 $ 240,629 $ 206,202
========== =========== ===========
Average total deposits increased 23.1% during 2002, 16.7% during 2001
and 10.3% during 2000. During 2002, the average balance of non-interest bearing
deposits grew 26.1%. The average balance in interest checking and money market
accounts grew 16.0% and 41.8%, respectively, during 2002. Management believes
that some of the growth in the average balances of money market accounts is
associated with the movement of money from the equity markets to bank accounts,
a significant portion of the growth is also core growth. The total number of net
new deposit transactional (excluding time deposits) accounts have increased 30%
per year for the past two years.
MFC will continue to fund assets primarily with deposits and will focus
on core deposit growth as the primary source of liquidity and stability. MFC
offers individuals and small to medium-sized businesses a variety of deposit
accounts, including demand and interest checking, money market, savings and time
deposit accounts. MFC neither purchases brokered deposits nor solicits deposits
from sources outside its primary market area.
-31-
The following table is a summary of the maturity distribution of
certificates of deposit equal to or greater than $100,000 as of December 31,
2002:
Maturities of Certificates of Deposit of $100,000 and Greater
Within Three to Six to Over Percent
Three Six Twelve One of Total
Months Months Months Year Total Deposits
------------- ------------ ------------- ------------ ------------- ------------
(In thousands)
At December 31, 2002 $9,784 $12,653 $9,470 $24,729 $56,636 17.2%
Capital Resources and Dividends
MFC has an ongoing strategic objective of maintaining a capital base
that supports the pursuit of profitable business opportunities, provides
resources to absorb risks inherent in its activities and meets or exceeds all
regulatory requirements.
The Federal Reserve Board has established minimum regulatory capital
standards for bank holding companies and state member banks. The regulatory
capital standards categorize assets and off-balance sheet items into four
categories that weigh balance sheet assets according to risk, requiring more
capital for holding higher risk assets. The minimum ratio of qualifying total
capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1
capital, composed of common equity and retained earnings. MFC had a ratio of
total capital to risk-weighted assets of 15.6% at December 31, 2002, compared to
17.3% at December 31, 2001. The ratio of Tier 1 capital to risk-weighted assets
was 14.8% and 16.4% at December 31, 2002 and 2001, respectively. Both ratios
exceed the minimum capital requirements adopted by the federal banking
regulatory agencies.
-32-
Analysis of Capital
December 31,
2002 2001
-------------- ---------------
(Dollars in thousands)
Tier 1 Capital:
Common stock $ 9,263 $ 8,761
Capital surplus 3,644 741
Retained earnings 25,184 21,084
Trust preferred debt 10,000 9,770
Goodwill (6,902) (1,272)
--------- ---------
Total Tier 1 capital $ 41,189 $ 39,084
--------- ---------
Tier 2 Capital:
Disallowed trust preferred $ - $ 230
Allowance for loan losses 2,307 2,060
--------- ---------
Total tier 2 capital $ 2,307 $ 2,290
--------- ---------
Total risk-based capital $ 43,496 $ 41,374
========= =========
Risk weighted assets $ 278,229 $ 238,605
CAPITAL RATIOS:
Tier 1 risk-based capital ratio 14.8% 16.4%
Total risk-based capital ratio 15.6% 17.3%
Tier 1 capital to average total
assets 10.6% 12.5%
MFC's core equity to asset ratio increased to 9.7% at December 31,
2002, compared to 8.6% at December 31, 2001. The issuance of additional shares
in the acquisition of GPIA as well as the exercise of 40,550 stock options have
contributed to the increase in capital and the equity to asset ratio in 2002.
The primary source of funds for dividends paid by MFC to its
shareholders is the dividends received from its subsidiaries. Federal regulatory
agencies impose certain restrictions on the payment of dividends and the
transfer of assets from the banking subsidiaries to the holding company.
Historically, these restrictions have not had an adverse impact on MFC's
dividend policy, and it is not anticipated that they will in the future.
Liquidity
Liquidity represents an institution's ability to meet present and
future financial obligations through either the sale or maturity of existing
assets or the acquisition of additional funds through liability management.
Liquid assets include cash, interest-bearing deposits with banks, federal funds
sold, short-term investments, securities classified as available for sale as
well as loans and securities maturing within one year. As a result of MFC's
management of liquid assets and the ability to generate liquidity through