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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
   
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934
   
For the quarterly period ended March 31, 2004
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934
   
 
For the transition period from ____________________ to _____________________.
 
COMMISSION FILE NO. 000-49747

 
FIRST SECURITY GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

Tennessee
 
58-2461486

 

(State of Incorporation)
 
(I.R.S. Employer
 
 
Identification No.)

 

817 Broad Street, Chattanooga, TN
 
37402

 

(Address of principal executive offices)
 
(Zip Code)

(423) 266-2000

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address, and former fiscal year,
if changed since last report)

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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).                 Yes x  No o

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common Stock, $.0083 par value:
10,587,639 shares outstanding and issued as of April 29, 2004

 
   

 
 
First Security Group, Inc. and Subsidiary

Form 10-Q

INDEX

PART I.
FINANCIAL INFORMATION
 
Page No.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
3
 
 
 
 
 
 
4
 
 
 
 
 
 
6
 
 
 
 
 
 
7
 
 
 
 
 
 
9
 
 
 
 
Item 2.
 
10
 
 
 
 
Item 3.
 
21
       
Item 4.
 
22
       
Part II
 
 
       
Item 6.
 
23
 
 
 
 
 
24

 
  2  

Table of Contents

PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements

First Security Group, Inc. and Subsidiary
 
 
 
 
Consolidated Balance Sheets
 

March 31,

 

December 31,

 

March 31,

 

 

 

2004

 

2003

 

2003

 

 

 

(unaudited)

 

 

 

 

(unaudited)

 

 
 
 

(in thousands)

 
ASSETS
   
 
   
 
   
 
 
Cash and due from banks
 
$
18,406
 
$
25,662
 
$
22,677
 
Federal funds sold and securities purchased
   
 
   
 
   
 
 
under agreements to resell
   
4,690
   
6,972
   
46,774
 
   
 
 
 
Cash and cash equivalents
   
23,096
   
32,634
   
69,451
 
   
 
 
 
Interest-bearing deposits in banks
   
2,897
   
4,512
   
3,380
 
   
 
 
 
Securities available for sale
   
89,407
   
86,499
   
71,222
 
   
 
 
 
Loans
   
489,303
   
478,013
   
422,211
 
Less: Allowance for loan losses
   
5,641
   
5,827
   
6,769
 
   
 
 
 
 
   
483,662
   
472,186
   
415,442
 
   
 
 
 
Premises and equipment, net
   
25,118
   
24,517
   
17,944
 
   
 
 
 
Intangible assets
   
15,394
   
15,704
   
12,769
 
   
 
 
 
Other assets
   
8,326
   
8,713
   
7,322
 
   
 
 
 
TOTAL ASSETS
 
$
647,900
 
$
644,765
 
$
597,530
 
   
 
 
 
 
   
 
   
 
   
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
   
 
   
 
   
 
 
LIABILITIES
   
 
   
 
   
 
 
Deposits
   
 
   
 
   
 
 
Noninterest bearing demand
 
$
101,692
 
$
100,192
 
$
85,491
 
Interest bearing demand
   
51,047
   
51,505
   
37,598
 
Savings
   
129,398
   
128,662
   
117,964
 
Certificates of deposit of $100 thousand or more
   
96,852
   
95,162
   
97,596
 
Certificates of deposit less than $100 thousand
   
165,224
   
164,783
   
152,887
 
   
 
 
 
Total deposits
   
544,213
   
540,304
   
491,536
 
Federal funds purchased and securities sold
   
 
   
 
   
 
 
under agreement to repurchase
   
12,234
   
12,069
   
12,403
 
Other borrowings
   
4,157
   
6,159
   
9,166
 
Other liabilities
   
3,800
   
3,795
   
4,674
 
   
 
 
 
Total liabilities
   
564,404
   
562,327
   
517,779
 
   
 
 
 
STOCKHOLDERS' EQUITY
   
 
   
 
   
 
 
Common stock - $.0083 par value - 20,000,000 shares
   
 
   
 
   
 
 
authorized; 10,587,639 issued as of March 31, 2004;
   
 
   
 
   
 
 
10,584,867 issued as of December 31, 2003;
   
 
   
 
   
 
 
and 10,497,353 issued as of March 31, 2003
   
88
   
88
   
88
 
Paid-in surplus
   
77,981
   
77,958
   
77,398
 
Retained earnings
   
4,645
   
3,995
   
1,875
 
Accumulated other comprehensive income
   
782
   
430
   
590
 
Deferred compensation on restricted stock
   
-
   
(33
)
 
(200
)
   
 
 
 
Total stockholders' equity
   
83,496
   
82,438
   
79,751
 
   
 
 
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
647,900
 
$
644,765
 
$
597,530
 
   
 
 
 

 
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Table of Contents

First Security Group, Inc. and Subsidiary
Consolidated Income Statements
(Unaudited)

 
 

Three Months Ended

 
 
 

March 31,

 
(In thousands except per share amounts)
 

2004

 

2003

 
INTEREST INCOME
   
 
   
 
 
Loans, including fees
 
$
7,755
 
$
6,173
 
Debt securities -taxable
   
558
   
409
 
Debt securities -non-taxable
   
169
   
95
 
Other
   
68
   
118
 
   
 
 
Total interest income
   
8,550
   
6,795
 
   
 
 
 
   
 
   
 
 
INTEREST EXPENSE
   
 
   
 
 
Interest bearing demand deposits
   
41
   
32
 
Savings deposits
   
255
   
383
 
Certificates of deposit of $100 thousand or more
   
619
   
639
 
Certificates of deposit of less than $100 thousand
   
1,032
   
916
 
Other
   
87
   
102
 
   
 
 
Total interest expense
   
2,034
   
2,072
 
   
 
 
 
   
 
   
 
 
NET INTEREST INCOME
   
6,516
   
4,723
 
Provision for loan losses
   
675
   
752
 
   
 
 
NET INTEREST INCOME AFTER PROVISION
   
 
   
 
 
FOR LOAN LOSSES
   
5,841
   
3,971
 
   
 
 
 
   
 
   
 
 
NONINTEREST INCOME
   
 
   
 
 
Service charges on deposit accounts
   
771
   
480
 
Mortgage loan fee income
   
247
   
460
 
Gain on securities
   
84
   
3
 
Other noninterest income
   
204
   
177
 
   
 
 
Total noninterest income
   
1,306
   
1,120
 
   
 
 
 
   
 
   
 
 
NONINTEREST EXPENSE
   
 
   
 
 
Salaries and employee benefits
   
3,430
   
2,614
 
Net occupancy
   
456
   
298
 
Equipment expense
   
480
   
321
 
Data processing fees
   
290
   
230
 
Amortization expense - CDI
   
229
   
61
 
Advertising expense
   
111
   
68
 
Supplies expense
   
168
   
108
 
Communications expense
   
107
   
95
 
Professional services
   
223
   
214
 
Postage expense
   
141
   
98
 
Other noninterest expense
   
592
   
497
 
   
 
 
Total noninterest expense
   
6,227
   
4,604
 
   
 
 

 
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Table of Contents


 
INCOME BEFORE INCOME TAX PROVISION
   
920
   
487
 
Income tax provision
   
270
   
151
 
   
 
 
NET INCOME
 
$
650
 
$
336
 
   
 
 
 
   
 
   
 
 
NET INCOME PER SHARE
   
 
   
 
 
BASIC
 
$
0.06
 
$
0.04
 
DILUTED
 
$
0.06
 
$
0.04
 
WEIGHTED AVERAGE SHARES OUTSTANDING
   
 
   
 
 
BASIC
   
10,586
   
9,119
 
DILUTED
   
10,763
   
9,215
 

 

 
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Table of Contents

First Security Group, Inc. and Subsidiary
Consolidated Statement of Stockholders' Equity

                   

 

 

 Deferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 Accumulated

 

 Compensation

 

 

 

 

 

Common Stock

 

 

 

 

 

 Other

 

 on

 

 

 

 

 


 

Paid-In

 

Retained 

 

Comprehensive

 

Restricted

   
(In thousands)
 

Shares

 

Amount

 

Surplus

 

Earnings

 

Income

 

  Stock

 

Total

 

 
 
 
 
 
 
 
 
Balance - December 31, 2003
   
10,585
 
$
88
 
$
77,958
 
$
3,995
 
$
430
 
$
(33
)
$
82,438
 
                                       
 
Comprehensive income -
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Net income (unaudited)
   
 
   
 
   
 
   
650
   
 
   
 
   
650
 
Change in net unrealized
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
gain on securities available
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
for sale, net of tax (unaudited)
   
 
   
 
   
 
   
 
   
352
   
 
   
352
 
                                       
 
                                             
Total comprehensive income (unaudited)
   
 
   
 
   
 
   
 
   
 
   
 
   
1,002
 
Common stock issued (unaudited)
   
3
   
 
   
23
   
 
   
 
   
33
   
56
 
   
 
Balance - March 31, 2004 (unaudited)
   
10,588
 
$
88
 
$
77,981
 
$
4,645
 
$
782
 
$
0
 
$
83,496
 
   
 

 
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Table of Contents

First Security Group, Inc. and Subsidiary
Consolidated Statements of Cash Flow
(Unaudited)

 
 

Three Months Ended

 
 
 

March 31,

 
   
 
(In thousands)
 

2004

 

2003

 

 
 
 
CASH FLOWS FROM OPERATING ACTIVITIES
   
 
   
 
 
Net income
 
$
650
 
$
336
 
Provision for loan losses
   
675
   
752
 
Net amortization of securities
   
223
   
179
 
Amortization of intangibles
   
229
   
60
 
Amortization of deferred stock compensation
   
33
   
-
 
Depreciation
   
397
   
228
 
Loss on disposal of assets
   
11
   
-
 
Gain on sale of available-for-sale securities
   
(84
)
 
(3
)
Changes in operating assets and liabilities -
   
 
   
 
 
Decrease (increase) in -
   
 
   
 
 
Interest receivable
   
( 8
)
 
295
 
Other assets
   
476
   
(1,061
)
Increase (decrease) in -
   
 
   
 
 
Interest payable
   
(310
)
 
(896
)
Other liabilities
   
134
   
1,748
 
   
 
 
Net cash provided by operating activities
   
2,426
   
1,638
 
   
 
 
 
   
 
   
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
   
 
   
 
 
Net change in interest bearing deposits
   
1,615
   
326
 
Activity in available-for-sale securities -
   
 
   
 
 
Sales
   
8,412
   
3,646
 
Maturities, prepayments, and calls
   
7,098
   
1,892
 
Purchases
   
(18,024
)
 
(13,570
)
Loan originations and principal collections, net
   
(12,151
)
 
(16,110
)
Proceeds from sale of fixed assets
   
-
   
-
 
Additions to premises and equipment
   
(1,009
)
 
(953
)
Net cash acquired in transaction accounted for
   
 
   
 
 
under the purchase method of accounting
   
-
   
14,198
 
   
 
 
Net cash used by investing activities
   
(14,059
)
 
(10,571
)
   
 
 
 
   
 
   
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
   
 
   
 
 
Net increase in deposits
   
3,909
   
33,232
 
Net increase in federal funds purchased and
   
 
   
 
 
securities sold under agreements to repurchase
   
165
   
681
 
Repayments of other borrowings
   
(2,002
)
 
(2
)
Proceeds from sale of common stock, net
   
23
   
-
 
   
 
 
Net cash provided by financing activities
   
2,095
   
33,911
 
   
 
 
NET INCREASE (DECREASE) IN CASH AND
   
 
   
 
 
CASH EQUIVALENTS
   
(9,538
)
 
24,978
 
CASH AND CASH EQUIVALENTS - beginning of period
   
32,634
   
44,473
 
   
 
 
CASH AND CASH EQUIVALENTS - end of period
 
$
23,096
 
$
69,451
 
   
 
 

 
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Table of Contents

Supplemental disclosures of noncash investing and
   
 
   
 
 
financing activities
   
 
   
 
 
Change in unrealized appreciation (depreciation) of securities,
   
 
   
 
 
net of deferred taxes of $181 for 2004 and $(3) for 2003
 
$
352
 
$
(5
)
Assets (noncash) acquired in business combination
 
$
-
 
$
75,314
 
Liabilities assumed in business combination
 
$
-
 
$
78,025
 
Issuance of common stock in business combination
 
$
-
 
$
11,487
 
Issuance of common stock pursuant to incentive plan
 
$
-
 
$
200
 
Supplemental schedule of cash flows
   
 
   
 
 
Interest paid
 
$
2,344
 
$
2,968
 
Income taxes paid
 
$
166
 
$
112
 

 
  8  

Table of Contents

FIRST SECURITY GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE A – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of financial condition and the results of operations have been included. All such adjustments were of a normal recurring nature. Certain reclassifications have been made to prior year amounts to conform with the current year presentation. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or any other period. The balance sheet as of December 31, 2003 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

NOTE B – COMPREHENSIVE INCOME

In accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income," the Company is required to report "comprehensive income," a measure of all changes in equity, not only reflecting net income but certain other changes as well. Comprehensive income for the three-month period ended March 31, 2004 and 2003, respectively, was as follows:

 
 

Three Months Ended

 
 
 

March 31,

 
   
 
(in thousands)
 

2004

 

2003

 

 
 
   
 
   
 
 
Net income
 
$
650
 
$
336
 
Unrealized gain (loss) - securities, net of tax
 
352
   
(5
)
   
 
 
Comprehensive income, net of tax
 
$
1,002
 
$
331
 
   
 
 

NOTE C – EARNINGS PER SHARE

Reference is made to Note 14, Long-Term Incentive Plan, in the Notes to Consolidated Financial Statements in First Security's Form 10-K, which contains descriptions of First Security's Stock Option Plan (the "Plan"). Shares under option under the Plan had a dilutive impact of less than $.01 on net income per share for the three months ended March 31, 2004.

NOTE D – REGULATORY AND ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities ("QSPEs") and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 2004. However, for special-purpose entities, First Security wou ld have been required to apply FIN 46 as of December 31, 2003. The Interpretation had no effect on First Security's consolidated financial statements.

 
  9  

Table of Contents

In March 2004, the FASB’s Emerging Issues Task Force (EITF) concluded its discussion of Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” A consensus was reached regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity Securities, and No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. The EITF provided guidance for evaluating whether an investment is other-than-temporarily impaired. This guidance should be applied in other-than-temporary impairment evaluations made in reporting periods beginning after June 15, 2004. The EITF consensus also requires certai n quantitative and qualitative disclosures which were effective in annual financial statements for fiscal years ending after December 15, 2003, for investments accounted for under Statements 115 and 124. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004. The additional disclosures for cost method investments are effective for fiscal years ending after June 15, 2004. The EITF consensus is not expected to have a material effect on First Security’s consolidated financial statements.

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this Form 10-Q, "First Security," "FSG," "we," "us," “the Company” and "our" refer to First Security Group, Inc.

FIRST QUARTER 2004 AND RECENT EVENTS

The following discussion and analysis sets forth the major factors that affected First Security's results of operations and financial condition reflected in the unaudited financial statements for the three-month periods ended March 31, 2004 and 2003. Such discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the notes attached thereto.

All per share data has been retroactively adjusted for the 12 for 10 stock split effected on June 16, 2003. As a result of the split, the par value has been adjusted from $.01 to $0.0083 per share.
 
OVERVIEW

As of March 31, 2004, First Security had total consolidated assets of $647.9 million, total loans of $489.3 million, total deposits of $544.2 million and stockholders' equity of $83.5 million. Our net income was $650 thousand for the three months ended March 31, 2004.

RESULTS OF OPERATIONS

Net income for the three months ended March 31, 2004, was $650 thousand, or $.06 per share (basic and diluted), compared to a net income of $336 thousand, or $.04 per share (basic and diluted) in the same period of 2003. Net interest income and noninterest income increased by $2 million, collectively, while noninterest expense, including provision for loan losses, increased by $1.5 million. Income increases outpaced expense increases as a result of the additional earning assets acquired through our acquisition and branching activity during 2003 and the first quarter of 2004.

Return on average assets (annualized) for the three months ended March 31, 2004 and 2003 was 0.40% and 0.28%, respectively. Return on average equity (annualized) for the three months ended March 31, 2004 and 2003 was 3.1% and 2.0%, respectively.

 
  10  

Table of Contents

Net Interest Income

Net interest income increased by $1.8 million or 38% to $6.5 million for the first quarter of 2004 compared to the same period a year ago. There are two factors that influence net interest income: (1) volume of earning assets and (2) rate of net interest margin on those earning assets.

Quarter-to-date average earning assets increased by $135.6 million or 30% to $583.7 million compared to average earning assets for the same period in 2003. On a year-to-year comparative basis, our earning assets increased due to (i) deposit gathering activities – deposits raised were used to fund or acquire earning assets and (ii) the acquisition of three Monroe County, Tennessee, branches from National Bank of Commerce in late 2003. These additional earning assets have enabled First Security to earn more interest income.

The other factors influencing net interest income are the yield on earning assets and the cost of funding liabilities. Changes in net interest margin did not influence net interest income as significantly as the changes in earning assets. On a fully tax equivalent basis, our net interest margin was 22 basis points higher in the first quarter of 2004 compared to the same period in 2003.

For the first quarter of 2004, 79% of average earning assets were funded with interest bearing liabilities, compared to 77% for the same period in 2003. In spite of an increase in interest bearing liabilities as a source of funding, our net interest margin improved from period-to-period. The margin improved because our weighted average yield earned on interest earning assets decreased at a slower pace than the decrease in our weighted average rate paid on interest bearing liabilities. We managed to minimize the decrease in the yield on interest earning assets by repositioning our mix of earning assets into higher yielding loans and investment securities. Overall, the decreases we experienced in our yield earned on earning assets and our rate paid on interest bearing liabilities resulted from the Federal Reserve Bank's rate reduction initiative during the prior three years to stimulate economic growth in the weakening U.S. economy. As a result of the Federal Reserve’s rate reductions and as our assets and liabilities continue to mature and reprice, we believe that the average rate earned on assets and our average rate paid on liabilities may continue to decrease over the next several months barring a Federal Reserve interest rate increase. If the Federal Reserve does increase interest rates, we believe that our net interest margin may increase because our assets reprice more frequently than our liabilities (see Item 3, Quantitative and Qualitative Disclosures About Market Risk).

The interest rate earned on loans for the three months ended March 31, 2004 decreased 65 basis points compared to the same period in 2003. The decrease is primarily attributable to the decreases in the prime lending rate, which were effected by the Federal Reserve rate cut initiative and the subsequent repricing of loans at lower rates. The yields on investment securities and other earning assets also decreased over the same periods. The overall yield on earning assets decreased 25 basis points in the first quarter of 2004 compared to the same period in 2003. The decrease in yield on earning assets was less than the decrease in the yield on loans due to the change in our mix of average earning assets. Average loans, which are our highest yielding earning assets, comprised 83% of earning assets in the first quarter of 2004, compared to 79% in the same period of the prior year.

For the first quarter of 2004, the cost of interest bearing liabilities decreased by 64 basis points from the same period in 2003. As a result, net interest spread for the first quarter of 2004 increased 39 basis points over the same period in the prior year. Deposit and loan rates are adjusted as market conditions and FSGBank’s needs allow. The following table summarizes net interest income and average yields and rates paid for the quarters ended March 31, 2004 and 2003.

 
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Table of Contents

Average Consolidated Balance Sheets and Net Interest Analysis
For the Three Months Ended March 31
Fully Tax-Equivalent Basis
(all dollar amounts in thousands)

   
 
 
 
 

2004

 

2003

 
   
 
 
 
 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

 

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 
   
 
 
Assets
   
 
   
 
   
 
   
 
   
 
   
 
 
Earning assets:
   
 
   
 
   
 
   
 
   
 
   
 
 
Loans, net of unearned income
 
$
486,610
 
$
7,755
   
6.41%
 
$
354,889
 
$
6,175
   
7.06%
 
Investment securities
   
86,988
   
844
   
3.90%
 
 
56,525
   
584
   
4.19%
 
Other earning assets
   
10,132
   
69
   
2.74%
 
 
36,713
   
118
   
1.30%
 
   
 

 
Total earning assets
   
583,730
   
8,668
   
5.97%
 
 
448,127
   
6,877
   
6.22%
 
         
             
       
Allowance for loan losses
   
(5,815
)
 
 
   
 
   
(5,401
)
 
 
   
 
 
Intangible assets
   
15,499
   
 
   
 
   
8,510
   
 
   
 
 
Cash & due from banks
   
20,263
   
 
   
 
   
13,546
   
 
   
 
 
Premises & equipment
   
24,888
   
 
   
 
   
13,603
   
 
   
 
 
Other assets
   
4,854
   
 
   
 
   
4,451
   
 
   
 
 
   
             
             
TOTAL ASSETS
 
$
643,419
   
 
   
 
 
$
482,836
   
 
   
 
 
   
             
             
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Liabilities and Stockholders' Equity
   
 
   
 
   
 
   
 
   
 
   
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Interest bearing liabilities:
   
 
   
 
   
 
   
 
   
 
   
 
 
NOW accounts
 
$
50,158
   
42
   
0.34%
 
$
27,573
   
32
   
0.47%
 
Money market accounts
   
97,536
   
223
   
0.92%
 
 
81,640
   
342
   
1.70%
 
Savings deposits
   
31,706
   
32
   
0.41%
 
 
18,170
   
41
   
0.92%
 
Time deposits < $100
   
165,581
   
1,033
   
2.51%
 
 
122,952
   
916
   
3.02%
 
Time deposits > $100
   
94,182
   
618
   
2.64%
 
 
78,391
   
639
   
3.31%
 
Federal funds purchased
   
5,016
   
18
   
1.44%
 
 
-
   
-
   
0.00%
 
Repurchase agreements
   
11,425
   
19
   
0.67%
 
 
12,348
   
34
   
1.12%
 
Other borrowings
   
4,365
   
52
   
4.79%
 
 
6,167
   
68
   
4.47%
 
   

 
 
Total interest bearing liabilities
   
459,969
   
2,037
   
1.78%
 
 
347,241
   
2,072
   
2.42%
 
         
       
 
Net interest spread
   
 
 
$
6,631
   
4.19%
 
 
 
 
$
4,805
   
3.80%
 
         
             
       
Noninterest bearing demand deposits
   
97,002
   
 
   
 
   
64,478
   
 
   
 
 
Accrued expenses and other liabilities
   
3,044
   
 
   
 
   
2,457
   
 
   
 
 
Stockholders' equity
   
82,843
   
 
   
 
   
68,028
   
 
   
 
 
Unrealized gain on securities
   
561
   
 
   
 
   
632
   
 
   
 
 
TOTAL LIABILITIES AND
 
   
 
   
 
 
   
 
   
 
 
STOCKHOLDERS' EQUITY
 
$
643,419
   
 
   
 
 
$
482,836
   
 
   
 
 
   
             
             
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Impact of noninterest bearing
   
 
   
 
   
 
   
 
   
 
   
 
 
sources and other changes in
   
 
   
 
   
 
   
 
   
 
   
 
 
balance sheet composition
   
 
   
 
   
0.38%
 
 
 
   
 
   
0.55%
 
               
             
 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Net yield on earning assets*
   
 
   
 
   
4.57%
 
 
 
   
 
   
4.35%
 
               
             
 
*Same as net interest margin
   
 
   
 
   
 
   
 
   
 
   
 
 
 
     
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Table of Contents
 
The following table presents the dollar amount of changes in interest income and interest expense from the three month period ended March 31, 2004 to the three month period ended March 31, 2003. The table distinguishes between the changes related to average outstanding (volume) of earning assets and interest bearing liabilities, as well as the changes related to average interest rates (rate) on such assets and liabilities.
 
 
Change in Interest Income and Expense on a Tax Equivalent Basis
For the Three Months Ended March 31
(all dollar amounts in thousands)

 
 

2004 Compared to 2003

 
 
 

Increase (Decrease)

 
 
 

in Interest Income and Expense

 
 
 

Due to Changes in:

 
   
 
 
 

Volume

 

Rate

 

Total

 
   
 
Interest earning assets:
   
 
   
 
   
 
 
Loans, net of unearned income
 
$
2,099
 
$
(519
)
$
1,580
 
Investment securities
   
296
   
(35
)
 
260
 
Other earning assets
   
(181
)
 
132
   
(49
)
   
 
Total earning assets
   
2,214
   
(423
)
 
1,791
 
   
 
 
   
 
   
 
   
 
 
Interest bearing liabilities:
   
 
   
 
   
 
 
NOW accounts
   
19
   
(9
)
 
10
 
Money market accounts
   
36
   
(155
)
 
(119
)
Savings deposits
   
14
   
(23
)
 
(9
)
Time deposits < $100
   
266
   
(149
)
 
117
 
Time deposits > $100
   
104
   
( 125
)
 
(21
)
Federal funds purchased
   
18
   
-
   
18
 
Repurchase agreements
   
(1
)
 
(14
)
 
(15
)
Other borrowings
   
(21
)
 
5
   
(16
)
   
 
Total interest bearing liabilities
   
435
   
( 470
)
 
(35
)
   
 
Increase in net interest income
 
$
1,779
 
$
47
 
$
1,826
 
   
 

 
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Table of Contents

Provision for Loan Losses

The provision for loan losses charged to operations during the three months ended March 31, 2004 was $675 thousand compared to $752 thousand in the same period of 2003. Net charge-offs for the first quarter of 2004 were $861 thousand compared to net charge-offs of $195 thousand for the same period in 2003. The 2004 charge-offs were the consequences of prior period decentralized credit underwriting standards, the lack of a year-round loan review program in prior years, and an increase in bankruptcy filings.

The allowance for loan losses reflects management's assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. We periodically analyze our loan portfolio in an effort to establish an allowance for loan losses that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:

°
our loan loss experience;
°
the amount of past due and nonperforming loans;
°
specific known risks;
°
the status and amount of past due and nonperforming assets;
°
underlying estimated values of collateral securing loans;
°
current and anticipated economic conditions; and
°
other factors which management believes affect the allowance for potential credit losses.

An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by FSGBank’s credit administration department and presented to the board of directors on a regular basis. In addition, our loan review department performs a regular review of the quality of the loan portfolio and adequacy of the allowance.

FSGBank’s allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses compared to a group of peer banks identified by the regulators. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance for loan loss methodology differ materially from ours.

While it is our policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management's judgment as to the adequacy of the allowance is necessarily approximate and imprecise.

As of March 31, 2004, the allowance for loan loss for FSGBank was $5.6 million or 1.15% of its outstanding loans. The peer group for FSGBank, as defined by the Federal Financial Institutions Examination Council's December 31, 2003 Uniform Bank Performance Report, includes all insured commercial banks between $500 million and $1 billion in average assets. This peer group, which includes 385 banks, had a ratio of the allowance for loan losses divided by total loans of 1.36% as of December 31, 2003, or 21 basis points more than FSGBank. Using our methodology, we believe that the allowance for loan loss for FSGBank was adequate as of March 31, 2004.

Noninterest Income

Noninterest income totaled $1.3 million for the first quarter of this year, an increase of $186 thousand, or 16.6%, from the same period in 2003. Deposit related income, comprised primarily of account service charges and non-sufficient fund charges, totaled $771 thousand for the first quarter of 2004, which was $291 thousand, or 60.6%, more than the corresponding quarter in 2003. Deposit related income increased as we gained deposits in our market areas and assumed deposits through the acquisitions of Premier National Bank and the three National Bank of Commerce branches in 2003, and we believe that this source of income will continue to be boosted by further deposit growth. Mortgage loan fees decreased by $213 thousand, or 46.3%, to $247 thousand for the first quarter of 2004 from the prior year. In the first quarter of 2004, rates for fixed rate residential 15- and 30-year loan prod ucts increased over those in the preceding year, and as a result, the mortgage refinancing activity was not as strong as that of the previous year. Based on current loan volumes, we believe that mortgage loan fees will remain near first quarter levels for the remainder of the year; however, based on current economic uncertainty and an increasing long term rate environment, mortgage fees may continue to decrease during 2004.

 
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Table of Contents

Noninterest Expense

Noninterest expense for the first quarter totaled $6.2 million, which was an increase of $1.6 million, or 35.3% over the first quarter of 2003. First Security's overhead ratio (noninterest expense, excluding amortization of intangible assets, provision for loan losses and income tax expenses, as a percentage of net interest income and noninterest income) decreased from 77.8% in the first quarter of 2003 to 76.7% for the same period in 2004.

Compared to the first quarter of 2003, salaries and benefits for the first quarter of 2004 increased $816 thousand or 31% to $3.4 million. The majority of the increase in salaries and benefits is related to staff additions for our branch openings and our acquisitions of Premier National Bank in March 2003 and the three National Bank of Commerce branches in December 2003. As of March 31, 2004, we had 26 full service branches (our 27th branch opened on April 5, 2004) and a total of 268 full time equivalent employees. As of March 31, 2003, we employed 228 full time equivalent employees and operated 19 full service branches and three loan production offices. We believe that salaries and benefits will increase for the remainder of 2004 as a result of our growth and branching efforts.

All noninterest expense categories are higher in the first quarter 2004 versus the same period in the prior year as a result of our branching activities and acquisitions of Premier National Bank and the three National Bank of Commerce bank branches. Occupancy expenses increased $158 thousand, or 53%, to $456 thousand. Furniture, fixtures and equipment expenses increased $159 thousand, or 50%, to $480 thousand. Data processing costs increased $60 thousand, or 26%, to $290 thousand. Supplies, communications, and postage expenses increased in aggregate by $115 thousand, or 38%, to $416 thousand. Advertising expense increased $43 thousand, or 63%, to $111 thousand. Professional services increased $9 thousand, or 4%, to $223 thousand.

The $229 thousand of first quarter amortization expense resulted from the amortization of the core deposit intangible assets created by the acquisitions of First State Bank (2002), Premier National Bank (2003) and the three National Bank of Commerce branches (2003). The core deposit intangible and goodwill created by the acquisition of First State Bank were $1 million and $1.4 million, respectively. The core deposit intangible and goodwill created by the acquisition of Premier National Bank were $1.3 million and $3 million, respectively. The core deposit intangible and goodwill created by the acquisition of the three National Bank of Commerce branches were $1.5 million and $754 thousand, respectively. The estimated useful life of each core deposit intangible asset is 10 years.

STATEMENT OF FINANCIAL CONDITION

First Security's total assets at March 31, 2004 were $647.9 million, $597.5 million at March 31, 2003 and $644.8 million at December 31, 2003. Average assets for the first quarter of 2004 were $643 million versus $483 million for the same period a year earlier, an increase of 33%. Of the $3.1 million increase in total assets in the first three months of 2004, approximately $3.0 million was from growth in deposits. First Security continues to actively pursue acquisitions and will continue to seek means to enhance our market share through further branching.

 
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Table of Contents

Loans

Average loans of $486.6 million represented 83% of our average earning assets during the first quarter of 2004. From December 31, 2003, gross loans increased $11.3 million to $489.3 million at March 31, 2004. The quarter-to-quarter growth is not only attributable to the Premier National Bank acquisition and the National Bank of Commerce branch acquisition in Monroe County in 2003, but also to the market growth from the relationships and ties of our bankers to the local communities in which they work. We believe that general loan demand will remain strong during 2004. Funding of future loan growth may be restricted by our ability to raise core deposits, although we will use alternative funding sources if necessary and cost effective. Loan growth may be further restricted by the necessity for us to maintain appropriate capital levels, as well as adequate liquidity.

Asset Quality

The allowance for loan losses was $5.6 million or 1.15% of outstanding loans at March 31, 2004 and $5.8 million or 1.22% of outstanding loans at December 31, 2003. The allowance for loan losses was 152.5% of nonperforming loans (defined as loans 90 days or more past due and nonaccrual loans) at March 31, 2004 and 245.1% of nonperforming loans at December 31, 2003. For the first three months of 2004, net charge-offs arising from loans secured by real estate totaled $21 thousand, commercial loans totaled $499 thousand, and consumer loans totaled $341 thousand (see Provision for Loan Losses). We believe that our reserve for inherent loan losses is adequate based on our assessment of the information available. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations of FSGBank, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant. The allocation of the allowance for loan losses by loan category at the dates indicated is presented below.

Allocation for Allowance for Loan Losses
As of March 31, 2004 and 2003
(in thousands)

 
 

2004

 

2003

 
 
   
 
 

Percentage of loans
in each

   
 
 

Percentage of loans
in each

 
Loan Categories
 

Amount

 

category to total loans

 

Amount

 

category to total loans

 
   
 
 
Commercial
 
$
2,024
   
24.5
%
$
3,035
   
24.9
%
Real estate-construction
   
239
   
9.9
%
 
332
   
8.5
%
Real estate-mortgage
   
2,657
   
49.9
%
 
2,348
   
50.4
%
Consumer
   
712
   
15.7
%
 
801
   
16.2
%
Charter condition or unallocated
   
9
   
-
   
253
   
-
 
   
 
 
Total
 
$
5,641
   
100.0
%
$
6,769
   
100.0
%
   
 
 

Nonperforming Assets

Nonaccrual loans were $2.3 million at March 31, 2004, $183 thousand at December 31, 2003 and $1.7 million at March 31, 2003. The nonaccrual loans in March 2004 included $453 thousand of commercial loans, $58 thousand of consumer loans, and $1.8 million of real-estate secured loans. The ratio of nonaccrual loans to total loans was 0.47% at March 31, 2004 and 0.038% at December 31, 2003. At March 31, 2004, we owned other real estate in the amount of $781 thousand.

Loans past due 90 days and still accruing were $1.4 million at March 31, 2004, compared to $2.2 million at December 31, 2003. Of these past due loans at March 31, 2004, $709 thousand were secured by real estate, $250 thousand were commercial loans and $449 thousand were consumer loans.

 
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Table of Contents

At March 31, 2004, nonperforming loans (nonaccrual loans and loans past due 90 days or more) were 0.76% of total outstanding loans, which is 6 basis points more than our peer group. Our Chief Loan Review Officer and Chief Credit Administration Officer recently implemented new procedures for enhanced monitoring of problem loans, as well as early detection, prevention and corrective action plans.

Investment Securities and Other Earning Assets

Securities totaled $89.4 million at March 31, 2004, $86.5 million at December 31, 2003 and $71.2 million at March 31, 2003. From first quarter end 2003 to first quarter end 2004, the growth in the securities portfolio occurred as a result of our efforts to improve our liquidity, as well as the acquisition of Premier National Bank. At March 31, 2004, the securities portfolio had unrealized net gains of approximately $782 thousand. In addition, all investment securities purchased to date have been classified as available-for-sale. The following table provides the amortized cost of our investment securities by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the approximate tax equivalent yields for each maturity range.

(in thousands)
 

Less than

 

One to

 

Five to

 

More than

 
 
 

One Year

 

Five Years

 

Ten Years

 

Ten Years

 
   
 
Municipal
 
$
2,040
 
$
2,453
 
$
9,069
 
$
9,983
 
Federal Agencies
   
11,977
   
44,281
   
6,370
   
2,048
 
   
 
Total
 
$
14,017
 
$
46,734
 
$
15,439
 
$
12,031
 
   
 
Tax Equivalent Yield
   
3.2
%
 
3.7
%
 
4.6
%
 
5.3
%
   
 
 
We currently have the ability and intent to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. Pledged securities as of March 31, 2004 totaled $21.4 million. Our management considers the overall quality of the securities portfolio to be high. All securities held are traded in liquid markets, except for one bond. This $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by The Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee. As of March 31, 2004, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our stockholders’ equity. As of the first quarter ended 2004, the amortized cost and mar ket value of the securities from each such issuer are as follows:

(in thousands)
 

Amortized Cost

 

Market Value

 
Fannie Mae
 
$
29,835
 
$
30,080
 
FHLMC*
 
$
20,457
 
$
20,603
 
FHLB**
 
$
12,667
 
$
12,880
 

* Federal Home Loan Mortgage Corporation
** Federal Home Loan Bank

The following table presents the amortized cost of the investments for the dates presented in the consolidated balance sheets.

(in thousands)
 

March 31, 2004

 

December 31, 2003

 

March 31, 2003

 
   
 
Federal agencies
 
$
64,676
 
$
63,964
 
$
51,399
 
Municipal
   
23,545
   
21,883
   
18,691
 
   
 
Total
 
$
88,221
 
$
85,847
 
$
70,090
 
   
 

Federal funds sold decreased to $4.7 million at March 31, 2004 from $7.0 million at December 31, 2003. The decrease in federal funds is a direct result of investing a portion of these funds into our loan and investment securities portfolio to improve our yield on earning assets.

 
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Table of Contents

Deposits and Other Borrowings

Total deposits increased 10.7% from March 31, 2003 to March 31, 2004, and 0.7% from December 31, 2003 to March 31, 2004. For the first three months of 2004, our branching activities yielded deposit growth of approximately $3.9 million. We anticipate that our deposits will continue to increase as a result of recent branch openings.

The following table details the maturities and rates of the term borrowings from the Federal Home Loan Bank.

Date
   
Type

 

 

Principal

 

 

Term

 

 

Rate

 

 

Maturity
 

 
1/8/2002
   
Fixed Rate Advance
   
500,000
   
36 months
   
4.48
%
 
1/7/05
 
1/8/2002
   
Fixed Rate Advance
   
500,000
   
48 months
   
5.04
%
 
1/6/06
 
1/10/2002
   
Fixed Rate Advance
   
500,000
   
36 months
   
4.45
%
 
1/10/05
 
1/10/2002
   
Fixed Rate Advance
   
500,000
   
48 months
   
5.00
%
 
1/10/06
 
1/15/2002
   
Fixed Rate Advance
   
500,000
   
36 months
   
4.22
%
 
1/14/05
 
1/15/2002
   
Fixed Rate Advance
   
500,000
   
48 months
   
4.77
%
 
1/13/06
 
1/17/2002
   
Fixed Rate Advance
   
500,000
   
36 months
   
4.37
%
 
1/14/05
 
1/17/2002
   
Fixed Rate Advance
   
500,000
   
48 months
   
4.90
%
 
1/17/06
 
         
                   
 
   
 
 
$
4,000,000
   
 
   
 
   
 
 
         
                   

Composite rate
4.65%
Composite 36 month rate
4.38%
Composite 48 month rate
4.92%


Liquidity

Liquidity refers to First Security’s ability to adjust its future cash flows to meet the needs of our daily operations. First Security relies primarily on management fees from FSGBank to fund our daily operations liquidity needs. Additionally, in connection with our 2002 private placement stock offering, we retained a portion of the proceeds of the offering as working capital and a portion of the proceeds for future investment into our subsidiary. First Security Group’s cash balance on deposit with FSGBank, which totaled approximately $6.7 million as of March 31, 2004, is available for funding activities for which FSGBank would not receive direct benefit, such as acquisition due diligence, shareholder relations, and holding company reporting and operations. These funds should adequately meet our cash flow needs. If we determine that our cash flow needs will be satisfactorily met, we may deploy a portion of the funds into FSGBank or use them in an acquisition in order to support continued growth.

The liquidity of FSGBank refers to the ability or financial flexibility to adjust its future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost effective basis. The primary sources of funds for FSGBank are cash generated by repayments of outstanding loans, interest payments on loans and new deposits. Additional liquidity is available from the maturity and earnings on securities and liquid assets, as well as the ability to liquidate securities available for sale.

At March 31, 2004, our liquidity ratio (defined as cash, due from banks, federal funds sold, and investment securities less securities pledged to secure liabilities divided by short-term funding liabilities less liabilities secured by pledged securities) was 18% (excluding anticipated loan repayments). As of December 31, 2003 and March 31, 2003, the liquidity ratios were 24.3% and 25.6% respectively. The decrease in our liquidity position is a direct result of investing a portion of these liquid funds into loans to improve our yield on earning assets. FSGBank could increase its borrowing capacity at the FHLB, subject to more stringent collateral requirements, by pledging loans other than 1-4 family residential mortgage loans.

 
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Table of Contents

Cumulatively, FSGBank also had unsecured federal funds lines in the aggregate amount of $42.8 million at March 31, 2004, under which it could borrow funds to meet short-term liquidity needs. Another source of funding that we have used and may continue to use is loan participations sold to other commercial banks (in which we retain the service rights). As of March 31, 2004, we had $13.3 million in loan participations sold. An additional source of short-term funding would be to pledge investment securities against a line of credit at a commercial bank. As of March 31, 2004, we had no borrowings against our investment securities, except for repurchase agreements entered into in the ordinary course of business. To date, First Security has not initiated the use of brokered deposits or Internet deposits as a source of funding; however, we assumed $4.2 million in brokered deposits with our a cquisition of Premier National Bank in 2003, with $2.1 million remaining on deposit at March 31, 2004. Our certificates of deposit greater than $100 thousand were gathered in our local communities. We believe that our liquidity sources are adequate to meet our operating needs.

First Security also has contractual cash obligations and commitments, which included certificates of deposit, other borrowings, operating leases, and loan commitments. As of March 31, 2004, certificates of deposit totaled $262 million. The scheduled maturities of certificates of deposit are as follows:

(Dollars amounts in thousands)
 

Less than 1 year

 

1 to 3 years

 

Over 3 years

 

Total

 
Certificates of Deposit
 
$
189,846

 

$
57,908

 

$
14,322

 

$
262,076
 

At March 31, 2004, other borrowings included $4 million in FHLB advances (see Management’s Discussion and Analysis of Financial Condition and Results of Operation - Deposits and Other Borrowings). Unfunded loan commitments and stand by letters of credit totaled $135 million and $4.3 million, respectively, at March 31, 2004. The following table illustrates our lease obligations, which included property and equipment leases, as of March 31, 2004.

(Dollars amounts in thousands)
 

Less than 1 year

 

1 to 3 years

 

3 to 5 years

 

After 5 years

 

Total

 
Lease Obligations
 
$
753

 

$
1,138

 

$
1,006

 

$
2,797

 

$
5,694

 


Net cash provided from or used by operations results primarily from net income or loss, adjusted for the following noncash accounting items: provision for loan losses, depreciation and amortization, and deferred income taxes or benefits. These items amounted to cash provided of $2.4 million for the three months ended March 31, 2004. Cash provided by operations was available to increase earning assets.

Capital Resources

We continue to maintain capital ratios in excess of regulatory minimum requirements. The current capital standards to be well capitalized call for a minimum total capital of 10% of risk-adjusted assets, including 6% Tier I capital, and a minimum leverage ratio of Tier I capital to total tangible assets of at least 5%. First Security and FSGBank maintain capital levels exceeding the minimum levels required for “well capitalized” banks and bank holding companies under applicable regulatory guidelines.
 
 
  19  

Table of Contents

March 31, 2004
 

Well
Capitalized

 

Adequately Capitalized

 

First
Security

 

FSGBank

   
 
   
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Tier I capital to risk adjusted assets
   
6.0
%
 
4.0
%
 
12.8
%
 
11.2
%
 
 
   
 
 
Total capital to risk adjusted assets
   
10.0
%
 
8.0
%
 
13.9
%
 
12.3
%
 
 
   
 
 
Leverage ratio
   
5.0
%
 
4.0
%
 
10.7
%
 
9.3
%
 
 
   
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
December 31, 2003
 

Well
Capitalized

 

Adequately Capitalized

 

First
Security

 

FSGBank*

   
 
   
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Tier I capital to risk adjusted assets
   
6.0
%
 
4.0
%
 
13.1
%
 
11.5
%
 
 
   
 
 
Total capital to risk adjusted assets
   
10.0
%
 
8.0
%
 
14.3
%
 
12.6
%
 
 
   
 
 
Leverage ratio
   
5.0
%
 
4.0
%
 
11.0
%
 
9.6
%
 
 
   
 
 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
March 31, 2003
 

Well
Capitalized

 

Adequately Capitalized

 

First
Security

 

FSGBank -
Dalton

 

FSGBank -
 Chattanooga

 

FSGBank -
Maynardville

 
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Tier I capital to risk adjusted assets
   
6.0
%
 
4.0
%
 
15.0
%
 
11.2
%
 
10.9
%
 
25.4
%
Total capital to risk adjusted assets
   
10.0
%
 
8.0
%
 
16.2
%
 
13.2
%
 
12.2
%
 
26.7
%
Leverage ratio
   
5.0
%
 
4.0
%
 
14.0
%
 
13.2
%
 
9.2
%
 
16.5
%
*On September 24, 2003, our three FSGBank charters (Dalton, Chattanooga, and Maynardville) were merged into one bank charter.

We have never paid any cash dividends on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to support the development and growth of our business. Payment of future dividends, if any, will be at the discretion of our board of directors and will depend upon our earnings, our financial condition, the capital adequacy of First Security and our subsidiary, opportunities for growth and expansion, the need for funds of our subsidiary, and other relevant factors, including applicable restrictions and governmental policies and regulations.

EFFECTS OF INFLATION

Inflation generally increases the cost of funds and operating overhead, and, to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of our assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on our performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In 2000, the Federal Reserve increased interest rates three times for a total of 100 basis points in an attempt to control inflation. However, in 2001 the Federal Reserve reduced interest rates on 11 occasions for a total of 475 basis points in an effort to stimulate economic growth. On N ovember 6, 2002, the Federal Reserve decreased interest rates by 50 basis points and on June 27, 2003, the Federal Reserve decreased interest rates 25 basis points in order to further stimulate economic growth. The Federal Reserve has made no rate adjustments thus far in 2004; however, Federal Reserve Chairman Alan Greenspan recently indicated that interest rates may increase sometime in 2004.

Inflation increases the cost of goods and services purchased, cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect the liquidity and earnings of our commercial banking and mortgage banking business, and our shareholders' equity. With respect to our mortgage banking business, mortgage originations and refinancings tend to slow as interest rates increase, and increased interest rates would likely reduce our earnings from such activities and our income from the sale of residential mortgage loans in the secondary market.

 
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Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the statements made under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere throughout this Form 10-Q are forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking statements relate to future events or our future financial performance and may involve known or unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of First Security to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Forward-looking statements include statements using the words such as "may," "will," "anticipate," "should," "would," "believe," "contemplate," "expect," "estimate," "continue," "intend," "seeks," or other similar words and expres sions of the future.

These forward-looking statements involve risks and uncertainties, and may not be realized due to a variety of factors, including, without limitation: the effects of future economic conditions, governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities; interest rate risks; the costs of evaluating possible acquisitions and the risks inherent in integrating acquisitions; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in First Security's market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; and the failure of assumptions underlying the establishment of reserves for possible loan losses. All written or oral forward-looking statements attributable to First Security are expressly qualified in their entirety by this Special Note.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk, with respect to First Security, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. First Security does not maintain a trading portfolio or deal in international instruments, and therefore First Security is not exposed to risk inherent to trading activities and foreign currency.

First Security's interest rate risk management is the responsibility of the Asset/Liability Committee ("ALCO"). ALCO has established policies and limits to monitor, measure and coordinate First Security's sources, uses, and pricing of funds.

Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with First Security's interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both a static and dynamic gap report to quantify the estimated exposure of net interest income to a sustained change in interest rates.

The gap analysis projected net interest income based on both a rise and fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month period. The model is based on actual repricing dates of interest sensitive assets and interest sensitive liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rates of certain assets.

First Security measures this exposure based on an immediate change in interest rates of up or down 200 basis points. Given this scenario, First Security had, at the end of the period, an exposure to falling rates and a benefit from rising rates. More specifically, for the period ended March 31, 2004 the model forecasts a decline in net interest income of $736 thousand or 11.29%, as a result of a 200 basis point decline in rates. The model also predicts a $563 thousand increase in net interest income, or 8.65% as a result of a 200 basis point increase in rates. The forecasted results of the model are within the limits specified by ALCO. The following chart reflects First Security's sensitivity to changes in interest rates as of March 31, 2004. The numbers are based on a static balance sheet, and the chart assumes that pay downs and maturities of both assets and liabilities are reinvest ed in like instruments at current interest rates, rates down 200 basis points, and rates up 200 basis points.

 
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Table of Contents

Interest Rate Risk
Income Sensitivity Summary
As of March 31, 2004
(in thousands)

 
 

DOWN
200 BP

 

CURRENT

 

UP
200 BP

 
 
   
 
   
 
   
 
 
Net interest income
 
$
5,780
 
$
6,516
 
$
7,079
 
Dollar change net interest income
   
(736
)
 
-
   
563
 
Percent change net interest income
   
-11.29
%
 
0.00
%
 
8.65
%

The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestment of paydowns and maturities of loans, investments and deposits, among others. In addition, there are no assumptions for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, management cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.

First Security recently purchased software from IPS-Sendero that we believe will enhance our ability to measure and manage interest rate risk and more efficiently aggregate financial data. The software components purchased were Data Management System, Sendero Vision Asset/Liability, General Ledger, EIS.net, and Budget and Planning System. We believe it will take several months to fully implement these systems.

The Sendero Vision Asset/Liability system is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration, and income simulations using a wide range of scenarios. The system also has the capability to model derivative instruments such as interest rate swap contracts. We will continue to use existing measurement tools until this system is fully implemented.

ITEM 4.  CONTROLS AND PROCEDURES

As of the end of the period covered by this report, First Security carried out an evaluation, under the supervision and with the participation of the Company’s management, including First Security’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, First Security’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiary) that is required to be included in First Security’s periodic filings with the Securities and Exchange Commission. There have been no changes in First Security’s internal controls over financial reporting during the quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 
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Table of Contents

PART II.  OTHER INFORMATION


ITEM 6.  Exhibits

(a)  Exhibits:
 
EXHIBIT NUMBER
DESCRIPTION
 
 
 
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
 
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
 
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934
 
 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934
 
 
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Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed by the undersigned, thereunto duly authorized.
 
 
 
FIRST SECURITY GROUP, INC.
 
 
 
(Registrant)
 
 
 
 
 
May 6, 2004
 
/s/ Rodger B. Holley
 

 
 
Rodger B. Holley
 
 
 
Chairman, Chief Executive Officer & President
 
 
 
 
 
May 6, 2004
 
/s/ William L. Lusk, Jr.
 

 
 
William L. Lusk, Jr.
 
 
 
Secretary, Chief Financial Officer &
 
 
 
Executive Vice President
 
 
 
  24